E2022025                                                        2022-12-30

Fang Liang  Lingshan Du  Zhuo Huang

Abstract

Efficiently exploiting the volatility information contained in price variations is im- portant for pricing options and other derivatives. In this paper, we develop a new and flexible option-pricing model that explicitly specifies the joint dynamics of overnight and intraday returns. The application of multivariate Edgeworth-Sargan density en- ables us to derive analytical approximations for option valuation formulas. Empirically, the model improves significantly upon benchmark models using S&P 500 index options. In particular, its separate modeling of intraday and overnight return volatility leads to an out-of-sample gain of 7.24% in pricing accuracy compared with the modeling of the close-to-close return volatility as a whole. The improvements are more pronounced during highly volatile periods.

Keywords: Overnight Volatility, Multivariate Edgeworth-Sargan Density, Option Pricing

JEL Classification: G13, C58, C51

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