Empirical Tests of an Option Price Inversion Approach

This paper presents an empirical test of Dupire's (1993) option price inversion approach using FT–SE 100 index options. The performance of option deltas determined using the Dupire approach is compared to the performance of a pair of Black-Scholes (1973) based deltas. The study finds that Black-Scholes based deltas out-perform the Dupire-deltas, which is consistent with the results in synthesized economies when there is a failure of Dupire's stochastic process assumption. This result suggests that fitting the term structure of volatility may be an inappropriate primary goal for a model intended to be used for option hedging purposes.