Good Volatility, Bad Volatility, and Option Pricing

Abstract

Advances in variance analysis permit the splitting of the total quadratic variation of a jump-diffusion process into upside and downside components. Recent studies establish that this decomposition enhances volatility predictions and highlight the upside/downside variance spread as a driver of the asymmetry in stock price distributions. To appraise the economic gain of this decomposition, we design a new and flexible option pricing model in which the underlying asset price exhibits distinct upside and downside semivariance dynamics driven by the model-free proxies of the variances. The new model outperforms common benchmarks, especially the alternative that splits the quadratic variation into diffusive and jump components.

COVID-19 Government restriction policy, COVID-19 vaccination and stock markets: Evidence from a global perspective

“…Similar to Feunou & Okou (2019) , Hussain (2020) and Lyu et al (2021) , we depart the total volatility into good and bad ones as below: where SGV i,t and SBV i,t are respectively good and bad volatilities of SlogR i,t , RGV i,t and RBV i,t are respectively good and bad volatilities of RlogR i,t for country i at time t.…”

Risk-Neutrality of RND and Option Pricing within an Entropy Framework

“…Given the initial time t 0 = 0, expiration T = 1, interest rate r = 0.05, dividend yield q = 0.02, and volatility σ = 0.2, the B-S RNMs m BS t 0 ,T ( j) (j = 1, 2) can be easily calculated using ( 14)- (15). Meanwhile, according to Section 2.2.1, for an underlying asset's price S 0 , numerically computing RNMs via integral expressions (1)-( 2) requires several pairs of "market-traded" options C(T, K) and P(T, K).…”

“…Neri and Schneider [11] investigate the proposition of the density of Buchen-Kelly within the family of maximum entropy densities and find that the densities converge to that of Buchen-Kelly in the sense of relative entropy. Some recent research related to entropy-valuation can also be found in [12,13] and more recently, in [14,15].…”

Forecasting aggregate market volatility: The role of good and bad uncertainties

“…Bollerslev, Li, and Zhao (2020) show that sorting the individual stocks into portfolios based on their good minus bad volatilities leads to economically and statistically significant differences in the subsequent portfolio returns. Feunou and Okou (2019) show that this decomposition of stock volatility is helpful for improving option pricing performance. Feunou, Jahan-Parvar, and Tédongap (2013) find that good and bad volatility has asymmetric effects on future returns.…”