ABSTRACT

 
We provide a joint analysis of return dynamics with Levy jumps under physical and risk neutral measures using stock and option prices . While the risk-neutral dynamics are important for option pricing, the physical dynamics are important for risk management, portfolio choices, and asset pricing.  Our joint analysis provides more accurate estimates of volatility variables, and model parameters under both measures, as well as estimates of market prices of risks that govern the change of measure process.  We discuss the change of measure and option pricing for infinite-activity Levy jumps.  We also develop efficient MCMC methods for estimating model parameters and latent state variables using both stock and option prices.  Using daily spot and option prices of the S&P 500 index, we show that models with infinite-activity Levy jumps in returns significantly outperform existing affine jump-diffusion models in capturing the joint dynamics of stock and option prices.
 
COFFEE: 3:45 p.m., 104 Snedecor Hall