Abstract
The research question we consider is whether incremental complexity in option pricing models is justified by incremental model performance. We apply the model confidence set as a formal model comparison approach in appraising stochastic volatility jump-diffusion option pricing models, spanning affine and nonaffine specifications. Jumps in price with stochastic (constant) arrival intensity produce superior (inferior) outcomes. A parsimonious negative exponential price jump distribution outperforms the popular normal distribution. Jumps in volatility (synchronized or not) worsen model performance. A parsimonious nonlinear hyperbolic drift extension of the Heston model performs particularly well. Nonlinear CEV models generally do not produce appreciable model performance.
| Original language | English |
|---|---|
| Pages (from-to) | 455-472 |
| Number of pages | 18 |
| Journal | Journal of Futures Markets |
| Volume | 45 |
| Issue number | 5 |
| Early online date | 26 Feb 2025 |
| DOIs | |
| Publication status | Published - 1 May 2025 |
Keywords
- affine and nonaffine jump-diffusion model specifications
- model complexity
- model confidence set
- option pricing models
- stochastic volatility
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