Short-term options with stochastic volatility: estimation and empirical performance

1. Fiorentini, Gabriele
2. León Valle, Angel
3. Rubio Irigoyen, Gonzalo

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This paper examines the stochastic volatility model suggested by Heston (1993). We employ a time-series approach to estimate the model and we discuss the potential effects of time-varying skewness and kurtosis on the performance of the model. In particular, it is found that the model tends to overprice out-of-the-money calls and underprice in-the-money calls. It is also found that the daily volatility risk premium presents a quite volatile behavior over time; however, our evidence suggests that the volatility risk premium has a negligible impact on the pricing performance of Heston¿s model.

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