Pricing and hedging long-term options

Do long-term and short-term options contain di!erential information? If so, can long-term options better di!erentiate among alternative models? To answer these questions, we "rst demonstrate analytically that di!erences among alternative models usually may not surface when applied to short-term options, but do so when applied to longterm contracts. Using S&P 500 options and LEAPS, we "nd that shortand long-term contracts indeed contain di!erent information. While the data suggest little gains from modeling stochastic interest rates or random jumps (beyond stochastic volatility) for pricing LEAPS, incorporating stochastic interest rates can nonetheless enhance hedging performance in certain cases involving long-term contracts. ( 2000 Elsevier Science S.A. All rights reserved. JEL classixcation: G10; G12; G13