Empirical assessment of an intertemporal option pricing model with latent variables

  • Luger R
  • Renault E
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This paper assesses the empirical performance of an intertemporal option pricing model with latent variables which generalizes the Black�Scholes and the stochastic volatility formulas. We derive a closed-form formula for an equilibrium model with recursive preferences where the fundamentals follow a Markov switching process. In a simulation experiment based on the model, we show that option prices are more informative about preference parameters than stock returns. When we estimate the preference parameters implicit in S&P 500 call option prices given our model, we find quite reasonable values for the coefficient of relative risk aversion and the intertemporal elasticity of substitution.

Author-supplied keywords

  • black
  • equilibrium option pricing
  • scholes implied volatility
  • smile e ect
  • stochastic volatility

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  • Richard Luger

  • Eric Renault

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