Pricing FTSE 100 index options under stochastic volatility

Yueh Neng Lin, Norman Strong, Xinzhong Xu

Research output: Contribution to journalArticlepeer-review

Abstract

The autoregressive conditional heteroscedasticity/generalized autoregressive conditional heteroscedasticity (ARCH/GARCH) literature and studies of implied volatility clearly show that volatility changes over time. This article investigates the improvement in the pricing of Financial Times-Stock Exchange (FTSE) 100 index options when stochastic volatility is taken into account. The major tool for this analysis is Heston's (1993) stochastic volatility option pricing formula, which allows for systematic volatility risk and arbitrary correlation between underlying returns and volatility. The results reveal significant evidence of stochastic volatility implicit in option prices, suggesting that this phenomenon is essential to improving the performance of the Black-Scholes model (Black & Scholes, 1973) for FTSE 100 index options. © 2001 John Wiley & Sons, Inc.
Original languageEnglish
Pages (from-to)197-211
Number of pages14
JournalJournal of Futures Markets
Volume21
Issue number3
DOIs
Publication statusPublished - Mar 2001

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