Article ID: | iaor20001594 |
Country: | Netherlands |
Volume: | 114 |
Issue: | 2 |
Start Page Number: | 249 |
End Page Number: | 262 |
Publication Date: | Apr 1999 |
Journal: | European Journal of Operational Research |
Authors: | Christodoulakis George A., Satchell Stephen E. |
Keywords: | simulation: applications |
We build a framework for modelling the deviation of observed option prices from the Black & Scholes prices. We use a flexible model for a density, a two sided switching Weibull, to capture the implied volatility. The model can be used to generate prices, it can take into account no-arbitrage bounds for option prices and is capable of generating such stylised facts as the smile effect. We apply this methodology to LIFFE options on German government bond futures.