We provide results for the valuation of European style contingent claims for a large class of specifications of the underlying asset returns. Our valuation results obtain in a discrete time, infinite state-space setup using the no-arbitrage principle and an equivalent martingale measure. Our...

Most recent empirical option valuation studies build on the affine square root (SQR) stochastic volatility model. The SQR model is a convenient choice, because it yields closed-form solutions for option prices. However, relatively little is known about the resulting biases. We investigate...

When the relationship between observed fixed-income securities and the latent state variables in dynamic term structure models is nonlinear, existing studies usually linearize this relationship because nonlinear filtering is computationally demanding. We propose the use of the unscented Kalman...

State-of-the-art stochastic volatility models generate a quot;volatility smirkquot; that explains why out-of-the-money index puts have high prices relative to the Black-Scholes benchmark. These models also adequately explain how the volatility smirk moves up and down in response to changes in...

There is extensive empirical evidence that index option prices systematically differ from Black-Scholes prices. Out-of-the-money put prices (and in-the-money call prices) are relatively high compared to the Black-Scholes price. Motivated by these empirical facts, we develop a new discrete-time...

Which loss function should be used when estimating and evaluating option valuation models? Many different functions have been suggested, but no standard has emerged. We do not promote a particular function, but instead emphasize that consistency in the choice of loss functions is crucial. First,...

Most recent empirical option valuation studies build on the affine square root (SQR) stochastic volatility model. The SQR model is a convenient choice, because it yields closed-form solutions for option prices. However, relatively little is known about the resulting biases.We investigate...

This paper presents a new model for the valuation of European options, in which the volatility of returns consists of two components. One of these components is a long-run component, and it can be modeled as fully persistent. The other component is short-run and has a zero mean. Our model can be...

Recent work by Engle and Lee (1999) shows that allowing for long-run and short-run components greatly enhances a GARCH model's ability fit daily equity return dynamics. Using the risk-neutralization in Duan (1995), we assess the option valuation performance of the Engle-Lee model and compare it...

Recent work by Engle and Lee (1999) shows that allowing for long-run and short-run components greatly enhances a GARCH model's ability to fit daily equity return dynamics. Using the risk-neutralization in Duan (1995), we assess the option valuation performance of the Engle-Lee model and compare...