Hostname: page-component-78c5997874-ndw9j Total loading time: 0 Render date: 2024-11-15T06:42:09.271Z Has data issue: false hasContentIssue false
  • English
  • Français

The Impact of Overnight Periods on Option Pricing

Published online by Cambridge University Press:  06 April 2009

Mark-Jan Boes ,
Feike C. Drost  and
Bas J. M. Werker
Mark-Jan Boes
Affiliation:
mboes@feweb.vu.nl, Finance Group, Free University Amsterdam, De Boelelaan 1105, 1081 HV, Amsterdam, The Netherlands
Feike C. Drost
Affiliation:
f.c.drost@uvt.nl, Econometrics and Finance Group, CentER, Tilburg University, P.O. Box 90153, 5000 LE, Tilburg, The Netherlands.
Bas J. M. Werker
Affiliation:
b.j.m.werker@uvt.nl, Econometrics and Finance Group, CentER, Tilburg University, P.O. Box 90153, 5000 LE, Tilburg, The Netherlands.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper investigates the effect of closed overnight exchanges on option prices. During the trading day, asset prices follow the literature's standard affine model that allows for stochastic volatility and random jumps. Independently, the overnight asset price process is modeled by a single jump. We find that the overnight component reduces the variation in the random jump process significantly. However, neither the random jumps nor the overnight jumps alone are able to empirically describe all features of option prices. We conclude that both random jumps during the day and overnight jumps are important in explaining option prices, where the latter account for about one quarter of total jump risk.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 2 , June 2007 , pp. 517 - 533
Copyright
Copyright © School of Business Administration, University of Washington 2007

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Amihud, Y., and Mendelson, H.. “Trading Mechanisms and Stock Returns: An Empirical Investigation.” Journal of Finance, 42 (1987), 533–553.CrossRefGoogle Scholar
Amihud, Y., and Mendelson, H.. “Volatility, Efficiency and Trading: Evidence from the Japanese Stock Market.” Journal of Finance, 46 (1991), 1765–1791.CrossRefGoogle Scholar
Anagnou, I.; Bedendo, M.; Hodges, S.; and Tompkins, R.. “The Relation between Implied and Realised Probability Density Functions.” Working Paper, University of Warwick (2002).CrossRefGoogle Scholar
Andersen, T. G.; Benzoni, L.; and Lund, J.. “An Empirical Investigation of Continuous-Time Equity Return Models.” Journal of Finance, 57 (2002), 1239–1284.CrossRefGoogle Scholar
Bakshi, G.; Cao, C.; and Chen, Z.. “Empirical Performance of Alternative Option Pricing Models.” Journal of Finance, 52 (1997), 2003–2049.CrossRefGoogle Scholar
Bakshi, G., and Kapadia, N.. “Delta-Hedged Gains and the Negative Volatility Risk Premium.” Review of Financial Studies, 16 (2003), 527–566.Google Scholar
Bakshi, G., and Madan, D. B.. “Spanning and Derivative-Security Valuation.” Journal of Financial Economics, 55 (2000), 205–238.CrossRefGoogle Scholar
Bates, D. “Post-'87 Crash Fears in S&P 500 Futures Options.” Journal of Econometrics, 94 (2000), 181–238.CrossRefGoogle Scholar
Black, F., and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–654.CrossRefGoogle Scholar
Bliss, R. R., and Panigirtzoglou, N.. “Testing the Stability of Implied Probability Density Functions.” Journal of Banking and Finance, 26 (2002), 381–422.CrossRefGoogle Scholar
Breeden, D. “An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities.” Journal of Financial Economics, 7 (1979), 265–296.CrossRefGoogle Scholar
Britten-Jones, M., and Neuberger, A.. “Option Prices, Implied Processes, and Stochastic Volatility.” Journal of Finance, 55 (2000), 839–866.CrossRefGoogle Scholar
Broadie, M.; Chernov, M.; and Johannes, M.. “Model Specification and Risk Premiums: Evidence from Futures Options.” Working Paper, Columbia University (2005).Google Scholar
Cao, C.; Choe, H.; and Hatheway, F.. “What is Special about the Opening? Evidence from Nasdaq.” Seoul Journal of Business, 3 (1997), 1–36.Google Scholar
Cao, C.; Ghysels, E.; and Hatheway, F.. “Price Discovery without Trading: Evidence from the Nasdaq Preopening.” Journal of Finance, 55 (2000), 1339–1365.CrossRefGoogle Scholar
Carr, P.; Geman, H.; Madan, D.; and Yor, M.. “Stochastic Volatility for Lévy Processes.” Mathematical Finance, 13 (2003), 345–382.CrossRefGoogle Scholar
Chernov, M.; Gallant, A. R.; Ghysels, E.; and Tauchen, G.. “Alternative Models of Stock Price Dynamics.” Journal of Econometrics, 116 (2003), 225–257.CrossRefGoogle Scholar
Christensen, B. J., and Prabhala, N. R.. “The Relation between Implied and Realized Volatility.” Journal of Financial Economics, 50 (1998), 125–150.CrossRefGoogle Scholar
Coutant, S.; Jondeau, E.; and Rockinger, M.. “Reading Interest Rate and Bond Future Options' Smiles around the 1997 French Snap Election.” CEPR (1998), no. 2010.Google Scholar
Coval, J. D., and Shumway, T.. “Expected Option Returns.” Journal of Finance, 56 (2001), 983–1009.CrossRefGoogle Scholar
Dubinsky, A., and Johannes, M.. “Earnings Announcements and Equity Options.” Working Paper, Columbia University (2005).Google Scholar
Duffie, D.; Pan, J.; and Singleton, K. J.. “Transform Analysis and Asset Pricing for Affine Jump-Diffusions.” Econometrica, 68 (2000), 1343–1376.CrossRefGoogle Scholar
Eraker, B.; Johannes, M. S.; and Polson, N.. “The Impact of Jumps in Volatility and Returns.” Journal of Finance, 53 (2003), 1269–1300.CrossRefGoogle Scholar
Fama, E. F. “The Behavior of Stock Market Prices.” Journal of Business, 38 (1965), 34–105.CrossRefGoogle Scholar
French, K. R. “Stock Returns and the Weekend Effect.” Journal of Financial Economics, 8 (1980), 55–69.CrossRefGoogle Scholar
French, K. R., and Roll, R.. “Stock Returns Variances: The Arrival of Information and the Reaction of Traders.” Journal of Financial Economics, 17 (1986), 5–26.CrossRefGoogle Scholar
Gibbons, M. R., and Hess, P.. “Day of the Week Effects and Asset Returns.” Journal of Business, 54 (1981), 579–596.CrossRefGoogle Scholar
Greene, J., and Watts, S.. “Price Discovery on the NYSE and the NASDAQ: The Case of Overnight and Daytime News Releases.” Financial Management, 25 (1996), 19–42.CrossRefGoogle Scholar
Heston, S. L. “A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options.” Review of Financial Studies, 6 (1993), 327–343.CrossRefGoogle Scholar
Hull, J., and White, A.. “The Pricing of Options on Assets with Stochastic Volatilities.” Journal of Finance, 42 (1987), 281–300.CrossRefGoogle Scholar
Jackwerth, J. C. “Option Implied Risk-Neutral Distributions and Implied Binomial Trees: A Literature Review.” Journal of Derivatives, 7 (1999), 66–82.CrossRefGoogle Scholar
Jackwerth, J. C., and Rubinstein, M.. “Recovering Probability Distributions from Option Prices.” Journal of Finance, 51 (1996), 1611–1631.CrossRefGoogle Scholar
Jones, C. M.; Kaul, G.; and Lipson, M. L.. “Information, Trading, and Volatility.” Journal of Financial Economics, 36 (1994), 127–154.CrossRefGoogle Scholar
Keim, D., and Stambaugh, R.. “A Further Investigation of the Weekend Effect in Stock Returns.” Journal of Finance, 39 (1984), 819–835.CrossRefGoogle Scholar
Madan, D. B.; Carr, P. P.; and Chang, E. C.. “The Variance Gamma Process and Option Pricing.” European Finance Review, 2 (1998), 79–105.CrossRefGoogle Scholar
Masulis, R., and Shivakumar, L.. “Intraday Market Response to Equity Offering Announcements: A NYSE/AMEX-Nasdaq Comparison.” Working Paper, Vanderbilt University (1997).Google Scholar
Merton, R. C. “Option Pricing when Underlying Stock Returns are Discontinuous.” Journal of Financial Economics, 3 (1976), 125–144.CrossRefGoogle Scholar
Oldfield, G. S., and Rogalski, R. J.. “A Theory of Common Stock Returns over Trading and Non-Trading Periods.” Journal of Finance, 35 (1980), 729–751.Google Scholar
Pan, J. “The Jump-Risk Premia Implicit in Options: Evidence from an Integrated Time-Series Study.” Journal of Financial Economics, 63 (2002), 3–50.CrossRefGoogle Scholar
Panigirtzoglou, N., and Skiadopoulos, G.. “A New Approach to Modeling the Dynamics of Implied Distributions: Theory and Evidence from the S&P 500 Options.” Journal of Banking and Finance, 28 (2004), 1499–1520.CrossRefGoogle Scholar
Scott, L. O. “Pricing Stock Options in a Jump-Diffusion Model with Stochastic Volatility and Interest Rates: Applications of Fourier Inversion Methods.” Mathematical Finance, 7 (1997), 413–426.CrossRefGoogle Scholar
Stoll, H., and Whaley, R.. “Stock Market Structure and Volatility.” Review of Financial Studies, 3 (1990), 37–71.CrossRefGoogle Scholar
Tompkins, R. “Implied Volatility Surfaces: Uncovering the Regularities for Options on Financial Futures.” European Journal of Finance, 7 (2001), 198–230.CrossRefGoogle Scholar