Asset price dynamics reflect unexpected events or shock announcements, commonly modelled in the literature as discontinuities in price trajectories or jumps. Using intraday data, it has nonetheless been observed that sharp movements of asset prices over short periods of time have often been attributed to jumps rather than to periods of high volatility. This paper proposes a new option pricing model in which jumps are replaced with volatility bursts in the dynamics of the underlying asset.
When estimated on Standard&Poor 500 index options and returns, the comparison with a number of alternative methods shows that the volatility burst component is an important and necessary ingredient for a more accurate option pricing and modelling of the implied volatility surface, with respect to both moneyness and the time to maturity.
Published in 2023 in: Journal of Financial Econometrics, v.21, 3, pp. 678-713.
