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Estimation of market prices of risks in the GARCH diffusion model
Wu, Xinyu1; Zhou, Hailin1; Wang, Shouyang2
AbstractIn this paper we propose an estimation procedure which uses joint data on the underlying asset and option prices to extract market prices of return and volatility risks in the context of the G.A.R.C.H. diffusion model. The procedure is flexible and simple to implement. Firstly, a quasi-closed form pricing formula for European options in the G.A.R.C.H. diffusion model is derived. This result greatly eases the computational burden for computing option prices, and well suited for our model estimation. Then, based upon the joint data, we develop an efficient importance sampling-based maximum likelihood (E.I.S.-M.L.) estimation method for the objective and risk-neutral parameters of the G.A.R.C.H. diffusion model and a particle filter algorithm for latent state variable. Hence, this allows us to infer the market prices of risks that link the objective measure and the risk-neutral measure. Finally, we illustrate our approach using actual data on the Hang Seng Index (H.S.I.) and index warrant prices. The results show that both the return and volatility risks are priced by the market. Moreover, an option pricing study demonstrates that the market price of the volatility risk plays an important role in fitting option prices.
KeywordMarket prices of risks GARCH diffusion model option pricing efficient importance sampling maximum likelihood particle filter
Funding ProjectNational Natural Science Foundation of China[71501001] ; National Natural Science Foundation of China[71101001] ; M.O.E. (Ministry of Education in China) Project of Humanities and Social Sciences[14YJC790133] ; China Postdoctoral Science Foundation[2015M580416] ; Natural Science Foundation of Anhui Province of China[1408085QG139] ; Anhui Province College Excellent Young Talents Fund of China[2013SQRW025ZD]
WOS Research AreaBusiness & Economics
WOS SubjectEconomics
WOS IDWOS:000423620300002
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Document Type期刊论文
Corresponding AuthorWu, Xinyu
Affiliation1.Anhui Univ Finance & Econ, Sch Finance, Bengbu, Peoples R China
2.Chinese Acad Sci, Acad Math & Syst Sci, Beijing, Peoples R China
Recommended Citation
GB/T 7714
Wu, Xinyu,Zhou, Hailin,Wang, Shouyang. Estimation of market prices of risks in the GARCH diffusion model[J]. ECONOMIC RESEARCH-EKONOMSKA ISTRAZIVANJA,2018,31(1):15-36.
APA Wu, Xinyu,Zhou, Hailin,&Wang, Shouyang.(2018).Estimation of market prices of risks in the GARCH diffusion model.ECONOMIC RESEARCH-EKONOMSKA ISTRAZIVANJA,31(1),15-36.
MLA Wu, Xinyu,et al."Estimation of market prices of risks in the GARCH diffusion model".ECONOMIC RESEARCH-EKONOMSKA ISTRAZIVANJA 31.1(2018):15-36.
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