AbstractsBusiness Management & Administration

Modified GARCH Process and Variance Risk Premium

by Yushuang Jiang

Institution: University of Otago
Year: 0
Keywords: GARCH option pricing models
Record ID: 1309424
Full text PDF: http://hdl.handle.net/10523/5079


In this study, we modify the classical generalized autoregressive conditional heteroskedastic (GARCH) process by introducing a new uncertainty into the volatility process. We then change probability measures from physical to risk-neutral ones by extending Duan’s (1995) locally risk-neutral valuation relationship (LRNVR). With the information of both daily index returns and the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), we estimate daily variances and model parameters by using the maximum likelihood method. The new modified GARCH process solves the problem of variance risk premium in the GARCH option models completely.