American Option Pricing with Discrete and Continuous Time Models: An Empirical Comparison

Journal of Empirical Finance (Impact Factor: 0.84). 06/2011; 18(5). DOI: 10.2139/ssrn.1875847


This paper considers discrete time GARCH and continuous time SV models and uses these for American option pricing. We perform a Monte Carlo study to examine their differences in terms of option pricing, and we study the convergence of the discrete time option prices to their implied continuous time values. Finally, a large scale empirical analysis using individual stock options and options on an index is performed comparing the estimated prices from discrete time models to the corresponding continuous time model prices. The results indicate that, while the differences in performance are small overall, for in the money options the continuous time SV models do generally perform better than the discrete time GARCH specifications.

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    • "Among these models, Engle and Ng's (1993) nonlinear asymmetric GARCH model (NGARCH) has proven to be a strong contestant for tting stock returns, pricing options, and predicting volatility. Bollerslev and Mikkelsen (1996), Hsieh and Ritchken (2005), Christoersen et al. (2010), and Stentoft (2011), among others, all show that non ane GARCH models (such as the NGARCH) dominate ane models for both tting returns and option valuation. GARCH models also perform well in forecasting volatility. "
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