Option pricing under the double exponential jump‐diffusion model with stochastic volatility and interest rate

Chen, R; Li, Z; Zeng, L; Yu, L; Qi, L; Liu, JL

Abstract

This paper proposes an efficient option pricing model that incorporates stochastic interest rate (SIR), stochastic volatility (SV), and double exponential jump into the jump‐diffusion settings. The model comprehensively considers the leptokurtosis and heteroscedasticity of the underlying asset’s returns, rare events, and an SIR. Using the model, we deduce the pricing characteristic function and pricing formula of a European option. Then, we develop the Markov chain Monte Carlo method with latent variable to solve the problem of parameter estimation under the double exponential jump‐diffusion model with SIR and SV. For verification purposes, we conduct time efficiency analysis, goodness of fit analysis, and jump/drift term analysis of the proposed model. In addition, we compare the pricing accuracy of the proposed model with those of the Black–Scholes and the Kou (2002) models. The empirical results show that the proposed option pricing model has high time efficiency, and the goodness of fit and pricing accuracy are significantly higher than those of the other two models.

Citation

Chen, R., Li, Z., Zeng, L., Yu, L., Qi, L., & Liu, J. (2017). Option pricing under the double exponential jump‐diffusion model with stochastic volatility and interest rate. Journal of management science and engineering, 2(4), 252-289. https://doi.org/10.3724/SP.J.1383.204012

• Journal Article Type: Article
• Acceptance Date: Dec 3, 2017
• Online Publication Date: Dec 21, 2017
• Publication Date: Dec 21, 2017
• Deposit Date: Jan 3, 2018
• Publicly Available Date: Jan 3, 2018
• Journal: Journal of Management Science and Engineering
• Print ISSN: 2096-2320
• Volume: 2
• Issue: 4
• Pages: 252-289
• DOI: https://doi.org/10.3724/SP.J.1383.204012
• Publisher URL: http://dx.doi.org/10.3724/SP.J.1383.204012
• Related Public URLs: http://engine.scichina.com/publisher/CSPM/journal/JMSE?slug=Overview