463 – SPEED: Methodological Advances in Time Series: BandE Speed Session, Part 1
Empirical Testing of an Option Pricing Model With Memory
Dan Ellsworth
Colorado College
Makayla McDevitt
Colorado College
Flavia Sancier-Barbosa
Colorado College
Lochana Siriwardena
University of Indianapolis
We discuss the preliminary testing of a continuous option pricing model with memory and intrinsic stochastic volatility. The stock dynamics follows a nonlinear stochastic functional differential equation with a closed-form solution and the option pricing formula is a conditional expectation that can be simulated via Monte Carlo methods. We tested the model for the S&P500 index during two time periods: during and after the 2008-2009 financial crisis. The model's performance was compared to the Black-Scholes model for different memory lengths, contract expiration times, and moneyness. We found that the option pricing model with memory was more accurate than Black-Scholes during the crisis, while the opposite was true in the post-crisis period.