European Business Schools Librarian's Group

HEC Research Papers Series,
HEC Paris

No 969: What's Beneath the Surface? Option Pricing with Multifrequency Latent States

Laurent E. Calvet (), Marcus Fearnley (), Fisher Adlai J. () and Leippold Markus ()

Abstract: We introduce a tractable class of non-affine price processes with multifrequency stochastic volatility and jumps. The specifi cations require few fixed parameters and deliver fast option pricing. One key ingredient is a tight link between jumps and volatility regimes, as asset pricing theory suggests. Empirically, the model matches implied volatility surfaces and their dynamics without requiring parameter recalibration. A variety of metrics show improvements over traditional benchmarks in- and out-of-sample.

Keywords: Markov-switching multifractal; particle filter; regime-switching; stochastic volatility; jump-risk premium; option pricing.

JEL-codes: C51; G12; G13

52 pages, January 18, 2013

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