Estimating and Testing Option Pricing Models in an Economy with Transaction Costs
Author | : Hyoung-jin Park |
Publisher | : |
Total Pages | : 30 |
Release | : 2008 |
ISBN-10 | : OCLC:1290313822 |
ISBN-13 | : |
Rating | : 4/5 (22 Downloads) |
Book excerpt: We examine the effect of transaction costs on implied volatility structure, parameter estimation, and hedging. Using simulations, we document that: (1) Transaction costs can generate the volatility smile phenomena even in the Black-Scholes economy. Especially, volatility smile effect is very strong for short-term options and it disappears as the maturity of options becomes longer. (2) Transaction costs cannot reject the true model falsely. All the parameter values that are supposed to be zero are not statistically significant even in the presence of transaction costs. (3) In hedging, the Black-Scholes model performs better than any other model in any case. This may result from the parameter instability of the cross-sectional estimation method.