Pricing and hedging long-term options

Gurdip Bakshi, Quanwei Cao, Zhiwu Chen

Research output: Contribution to journalArticle

108 Citations (Scopus)

Abstract

Do long-term and short-term options contain differential information? If so, can long-term options better differentiate among alternative models? To answer these questions, we first demonstrate analytically that differences among alternative models usually may not surface when applied to short-term options, but do so when applied to long-term contracts. Using S&P 500 options and LEAPS, we find that short- and long-term contracts indeed contain different information. While the data suggest little gains from modeling stochastic interest rates or random jumps (beyond stochastic volatility) for pricing LEAPS, incorporating stochastic interest rates can nonetheless enhance hedging performance in certain cases involving long-term contracts.

Original languageEnglish (US)
Pages (from-to)277-318
Number of pages42
JournalJournal of Econometrics
Volume94
Issue number1-2
DOIs
StatePublished - Jan 1 2000

Fingerprint

Hedging
Pricing
Stochastic Interest Rates
Costs
Stochastic Volatility
Alternatives
Differentiate
Jump
Modeling
Model
Demonstrate
Long-term contracts
Stochastic interest rates
Alternative models

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

Cite this

Bakshi, Gurdip ; Cao, Quanwei ; Chen, Zhiwu. / Pricing and hedging long-term options. In: Journal of Econometrics. 2000 ; Vol. 94, No. 1-2. pp. 277-318.
@article{132fa0ca18eb4208b8163de3bd8f4723,
title = "Pricing and hedging long-term options",
abstract = "Do long-term and short-term options contain differential information? If so, can long-term options better differentiate among alternative models? To answer these questions, we first demonstrate analytically that differences among alternative models usually may not surface when applied to short-term options, but do so when applied to long-term contracts. Using S&P 500 options and LEAPS, we find that short- and long-term contracts indeed contain different information. While the data suggest little gains from modeling stochastic interest rates or random jumps (beyond stochastic volatility) for pricing LEAPS, incorporating stochastic interest rates can nonetheless enhance hedging performance in certain cases involving long-term contracts.",
author = "Gurdip Bakshi and Quanwei Cao and Zhiwu Chen",
year = "2000",
month = "1",
day = "1",
doi = "10.1016/S0304-4076(99)00023-8",
language = "English (US)",
volume = "94",
pages = "277--318",
journal = "Journal of Econometrics",
issn = "0304-4076",
publisher = "Elsevier BV",
number = "1-2",

}

Pricing and hedging long-term options. / Bakshi, Gurdip; Cao, Quanwei; Chen, Zhiwu.

In: Journal of Econometrics, Vol. 94, No. 1-2, 01.01.2000, p. 277-318.

Research output: Contribution to journalArticle

TY - JOUR

T1 - Pricing and hedging long-term options

AU - Bakshi, Gurdip

AU - Cao, Quanwei

AU - Chen, Zhiwu

PY - 2000/1/1

Y1 - 2000/1/1

N2 - Do long-term and short-term options contain differential information? If so, can long-term options better differentiate among alternative models? To answer these questions, we first demonstrate analytically that differences among alternative models usually may not surface when applied to short-term options, but do so when applied to long-term contracts. Using S&P 500 options and LEAPS, we find that short- and long-term contracts indeed contain different information. While the data suggest little gains from modeling stochastic interest rates or random jumps (beyond stochastic volatility) for pricing LEAPS, incorporating stochastic interest rates can nonetheless enhance hedging performance in certain cases involving long-term contracts.

AB - Do long-term and short-term options contain differential information? If so, can long-term options better differentiate among alternative models? To answer these questions, we first demonstrate analytically that differences among alternative models usually may not surface when applied to short-term options, but do so when applied to long-term contracts. Using S&P 500 options and LEAPS, we find that short- and long-term contracts indeed contain different information. While the data suggest little gains from modeling stochastic interest rates or random jumps (beyond stochastic volatility) for pricing LEAPS, incorporating stochastic interest rates can nonetheless enhance hedging performance in certain cases involving long-term contracts.

UR - http://www.scopus.com/inward/record.url?scp=0003289586&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=0003289586&partnerID=8YFLogxK

U2 - 10.1016/S0304-4076(99)00023-8

DO - 10.1016/S0304-4076(99)00023-8

M3 - Article

VL - 94

SP - 277

EP - 318

JO - Journal of Econometrics

JF - Journal of Econometrics

SN - 0304-4076

IS - 1-2

ER -