Parametric Inference and Dynamic State Recovery from Option Panels

Torben Andersen, Nicola Fusari and Viktor Todorov

No 18046, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a new parametric estimation procedure for option panels observed with error which relies on asymptotic approximations assuming an ever increasing set of observed option prices in the moneyness- maturity (cross-sectional) dimension, but with a fixed time span. We develop consistent estimators of the parameter vector and the dynamic realization of the state vector that governs the option price dynamics. The estimators converge stably to a mixed-Gaussian law and we develop feasible estimators for the limiting variance. We provide semiparametric tests for the option price dynamics based on the distance between the spot volatility extracted from the options and the one obtained nonparametrically from high-frequency data on the underlying asset. We further construct new formal tests of the model fit for specific regions of the volatility surface and for the stability of the risk-neutral dynamics over a given period of time. A large-scale Monte Carlo study indicates the inference procedures work well for empirically realistic specifications and sample sizes. In an empirical application to S&P 500 index options we extend the popular double-jump stochastic volatility model to allow for time-varying jump risk premia and a flexible relation between risk premia and the level of risk. Both extensions lead to an improved characterization of observed option prices.

JEL-codes: C51 C52 C58 G12 G13 (search for similar items in EconPapers)
Date: 2012-05
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

Published as Torben G. Andersen & Nicola Fusari & Viktor Todorov, 2015. "Parametric Inference and Dynamic State Recovery From Option Panels," Econometrica, vol 83(3), pages 1081-1145.

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Related works:
Journal Article: Parametric Inference and Dynamic State Recovery From Option Panels (2015)
Working Paper: Parametric Inference and Dynamic State Recovery from Option Panels (2012)
Working Paper: Parametric Inference and Dynamic State Recovery from Option Panels (2011)
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