Evaluating the Performance of Structural Option Pricing Models
Mathematical Modelling and Applied Computing (MMAC), Vol. 3, No. 1, pp. 1–9, 2012
9 Pages Posted: 17 Aug 2011 Last revised: 4 May 2013
Date Written: December 11, 2010
Abstract
We propose new methodology to evaluate the empirical performance of structural option pricing models. Christoffersen, Jacobs, and Heston (2009) and Orosi (2010) point out that ad hoc models signi ficantly outperform structural models. These results are based on how well the models replicate liquid European or American-style options. However, the performance of structural option pricing models should be based on how accurately these models price exotic options. Previously, binary option contracts have been traded over-the-counter and no liquid prices were available. In May 2008, exchange-traded European cash-or-nothing binary options had been launched by the American Stock Exchange (Amex), which was followed by the Chicago Board Options Exchange (CBOE) in June 2008. Therefore, it can observed now how accurately the models calibrated to European-style or American-style options match the prices of the quoted binary options. We implement this procedure to asses the pricing accuracy of several structural option pricing models on a single trading day.
Keywords: exotic option pricing, calibration, empirical performance
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