Date of Award
Bachelor of Business Honours
Faculty of Business and Public Management
We aim to test two things. Firstly, whether accounting for the persistence in volatility decreases the errors between the option prices implied from our models and the observed option prices and secondly, whether the pricing errors are reduced when you allow for the fact that consumption is correlated with returns on the underlying asset. Three option pricing models are developed and tested. 1-The Black and Scholes option pricing model, 2-The GARCH (1,1) model under risk neutrality and 3- The GARCH (1,1) model under systematic consumption risk, using recent daily data on traded options on the FTSE 100 share price index. Our findings suggest that when the persistence of the volatility of the underlying asset is accounted for, the pricing errors converge to the observed option prices ever so slightly, and only for certain options. By allowing for systematic consumption risk, the implied option pricing model is more accurate than the other two models, but only for in-the-money call options. If the correlation between consumption and returns increases then this model will produce lower call option prices than the observed prices for in-the-money call options.
Georgievski, A. (2000). An Analysis of Option Pricing Under Systematic Consumption Risk Using GARCH. Retrieved from http://ro.ecu.edu.au/theses_hons/331