The simulation of option prices with application to LIFFE options on futures |
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| Affiliation: | 1. Department of Economics, Birkbeck College, University of London, 7-15 Gresse Street, London W1P 2LL, UK;2. Faculty of Economics and Trinity College, University of Cambridge, Sydgwick Avenue, Cambridge CB1 9DE, UK |
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| Abstract: | We build a framework for modelling the deviation of observed option prices from the Black & Scholes prices. We use a flexible model for a density, a two sided switching Weibull, to capture the implied volatility. The model can be used to generate prices, it can take into account no-arbitrage bounds for option prices and is capable of generating such stylised facts as the smile effect. We apply this methodology to LIFFE options on German government bond futures. |
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