GARCH Models: A Comparative Analysis
Competing Models for Option Pricing
In the realm of financial modeling, option pricing plays a crucial role in risk management and investment decisions. Among the various models employed for option pricing, two prominent contenders are the GARCH and stochastic volatility (SV) models.
GARCH vs. SV Models
The Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model captures the volatility clustering observed in financial time series data. Its variants provide greater flexibility in modeling volatility dynamics. On the other hand, SV models assume that volatility evolves as a stochastic process, offering a more nuanced representation of volatility.
Comparative Analysis
Studies have consistently shown that SV models generally outperform their GARCH counterparts in option pricing. SV models exhibit better accuracy in capturing both the level and dynamics of volatility, leading to more precise option price estimates.
Conclusion
The comparative analysis between GARCH and SV models highlights the advantages of SV models in option pricing. They provide a more sophisticated representation of volatility, resulting in improved option price accuracy. This understanding is crucial for investors and risk managers seeking effective tools for financial decision-making.
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