Option Pricing under Stochastic Volatility and Trading Volume

Sadayuki Ono
2004 Social Science Research Network  
This paper presents a pricing formula for European options derived from a model in which changes in the underlying price and trading volumes are jointly determined by exogenous events. This speci cation makes increments to the volatility depend on the current level of volatility and news and thereby accounts for the observed persistence in volatility. Moreover, it makes volatility an observable variable. The model accounts well for time varying volatility smiles and term structures, and that
more » ... -of-sample price forecasts for a sample of call options are superior to the benchmark ad hoc procedure of plugging implicit volatilities into the Black-Scholes formula. JEL Classi cation: G12; C52; C53 Keywords: option valuation; trading volume; the stochastic volatility and volume (SVV) model.
doi:10.2139/ssrn.676484 fatcat:gckhskp7bne6zpwajpxxwwxumy