Premium
An empirical test of the Hull‐White option pricing model
Author(s) -
Corrado Charles,
Su Tie
Publication year - 1998
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/(sici)1096-9934(199806)18:4<363::aid-fut1>3.0.co;2-k
Subject(s) - hull , valuation of options , test (biology) , econometrics , economics , financial economics , actuarial science , computer science , engineering , geology , marine engineering , paleontology
The Black-Scholes (1973) option pricing model provides the foundationfor the modern theory of options valuation. In actual applications, how-ever, the model has certain well-known deciencies. For example, whencalibrated to accurately price at-the-money options the Black-Scholes(1973) model often misprices deep in-the-money and deep out-of-the-money options. This model-anomalous behavior givesrisetowhatoptionsprofessionals call “volatility smiles.” A volatility smile is the skewed pat-tern that results from calculating implied volatilities across a range ofstrike prices for an option series. This phenomenon is not predicted bythe Black-Scholes (1973) model, since volatility is a property of the un-derlying instrument and the same implied volatility value should be ob-served across all options onthatinstrument.Volatilitysmilesaregenerallythought to result from the parsimonious assumptions used to derive theBlack-Scholes model. In particular, the Black-Scholes (1973) model as-sumes that security log prices follow a constant variance diffusion pro-cess. The constant variance assumption has been tested and rejected inearly studies by Beckers (1980), Black and Scholes (1972), Christie