Title: A discrete-time stochastic volatility framework for pricing options with realized measures
Authors: Roberto Casarin - University Ca' Foscari of Venice (Italy)
Giacomo Bormetti - University of Bologna (Italy)
Fulvio Corsi - University of Pisa and City University London (Italy)
Giulia Livieri - Scuola Normale Superiore (Italy) [presenting]
Abstract: Motivated by the fact that realized measures of volatility are affected by measurement errors, we introduce a new family of discrete-time stochastic volatility models having two measurement equations relating both the observed returns and realized measures to the latent conditional variance. A fully analytical option pricing framework is developed for this new discrete-time Stochastic Volatility class of models. In addition, we provide analytical filtering and smoothing recursions for the basic version of the model, and an effective MCMC algorithm for its richer variants. The empirical analysis shows the efficacy of the filtering and smoothing of realized measures in inating the latent volatility persistence - the crucial parameter for the effective pricing of Standard and Poor's 500 Index options.