Leverage effect on stochastic volatility for option pricing in Hong Kong: A simulation and empirical study |
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| Institution: | 1. Center for Central China Economic Development Research and School of Economics & Management, Nanchang University, Nanchang 330031, China;2. School of Finance, Nanjing University of Finance & Economics, Nanjing 210023, China;3. School of Business, Changzhou University, Changzhou 213164, China;1. Division of Economics, Nanyang Technological University, Singapore 639805, Singapore;2. School of Economics and Commerce, South China University of Technology, China;3. Research Center of Financial Engineering, South China University of Technology, China;1. Research Department, Hong Kong Monetary Authority, 55/F, Two International Finance Centre, 8 Finance Street, Central, Hong Kong, China;2. Institute of Theoretical Physics and Department of Physics, The Chinese University of Hong Kong, Shatin, New Territories, Hong Kong, China;1. Chulalongkorn University, Sasin Graduate Institute of Business Administration, Bangkok, Thailand;2. Chulalongkorn University, College of Population Studies, Bangkok, Thailand;3. Pennsylvania State University, School of Graduate Professional Studies, Malvern, PA, USA;1. College of Economics and Finance, Huaqiao University, Fujian, China;2. Department of Finance, National Chung-Hsing University, Taichung, Taiwan |
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| Abstract: | This paper explores the importance of incorporating the financial leverage effect in the stochastic volatility models when pricing options. For the illustrative purpose, we first conduct the simulation experiment by using the Markov Chain Monte Carlo (MCMC) sampling method. We then make an empirical analysis by applying the volatility models to the real return data of the Hang Seng index during the period from January 1, 2013 to December 31, 2017. Our results highlight the accuracy of the stochastic volatility models with leverage in option pricing when leverage is high. In addition, the leverage effect becomes more significant as the maturity of options increases. Moreover, leverage affects the pricing of in-the-money options more than that of at-the-money and out-of-money options. Our study is therefore useful for both asset pricing and portfolio investment in the Hong Kong market where volatility is an inherent nature of the economy. |
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| Keywords: | Stochastic volatility Leverage Option Markov Chain Monte Carlo |
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