Title

Pricing Options Using Implied Trees: Evidence from Ftse-100 Options

Publication Type

Journal Article

Publication Date

7-2002

Abstract

Previously, few comparative tests of performance of Jackwerth's (1997) generalized binomial tree (GBT) and Derman and Kani (1994) implied volatility tree models were done. In this paper, 5 different weight functions in GBT are proposed and are tested empirically compared to both the Black-Scholes model and IVT. With both American and European options traded on the FTSE-100 index, both GBT and IVT are constructed from European options and their performance in both the hedging of European option and the pricing of its American counterpart is examined. IVT is found to produce least hedging errors and best results for American call options with earlier maturity than the maturity span of the implied trees. GBT appears to produce better results for American ATM put pricing for any maturity, and better in-sample fit for options with maturity equal to the maturity span of the implied trees. Deltas calculated from IVT are consistently lower than Black-Scholes deltas for both European and American calls in absolute term. The reverse holds true for GBT deltas.

Discipline

Finance and Financial Management | Portfolio and Security Analysis

Research Areas

Finance

Publication

Journal of Futures Markets

Volume

22

Issue

7

First Page

601

Last Page

626

ISSN

0270-7314

Identifier

10.1002/fut.10019

Publisher

Wiley: 24 months