On the Empirical Behavior of Stochastic Volatility Models: Do Skewness and Kurtosis Matter?

Abstract

This chapter analyzes the empirical performance of alternative option pricing models using Black and Scholes (1973) as a benchmark. Specifically, we consider the Heston (1993) and Corrado and Su (1996) models and price call options on the S&P 500 index over the period from November 2010 to April 2011, evaluating each model by computing in- and out-of-sample pricing errors. We find that the two proposed models reduce both types of errors and mitigate the smile effect with respect to the benchmark. Moreover, in most of the cases, the model in Corrado and Su (1996) beats that in Heston (1993). Then, we conclude that skewness and kurtosis matter for option pricing purposes.

Citation

García-Alonso, M.M., Moreno, M. and Navas, J.F. (2012), "On the Empirical Behavior of Stochastic Volatility Models: Do Skewness and Kurtosis Matter?", Batten, J.A. and Wagner, N. (Ed.) Derivative Securities Pricing and Modelling (Contemporary Studies in Economic and Financial Analysis, Vol. 94), Emerald Group Publishing Limited, Leeds, pp. 227-257. https://doi.org/10.1108/S1569-3759(2012)0000094012