Cross-sectional tests of deterministic volatility functions

Cross-sectional tests of deterministic volatility functions

We study the cross-sectional performance of option pricing models in which the volatility of the underlying stock is a deterministic function of the stock price and time. For each date in our sample of FTSE 100 index option prices, we fit an implied binomial tree to the panel of all European style options with different strike prices and maturities and then examine how well this model prices a ...

Decomposing Cross-Sectional Volatility

Implied volatility functions: empirical tests

Black and Scholes (1973) implied volatilities tend to be systematically related to the option’s exercise price and time to expiration. Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) attribute this behavior to the fact that the Black/Scholes constant volatility assumption is violated in practice. These authors hypothesize that the volatility of the underlying asset’s return is a de...

Robustifying Common Deterministic Trend Tests to Nonstationary Volatility

This article studies multivariate deterministic trend function testing when there are unknown structural changes in the volatility process. Several tests based on least squares estimation are analyzed and compared, and among them, one is robust to unknown nonstationary volatility. It is shown that the standard common trend tests of Vogelsang and Franses (2005) are generally non-pivotal, involvi...

Cross Sectional Asset Pricing Tests