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The Impact of Overnight Periods on Option Pricing

Published online by Cambridge University Press:  06 April 2009

Mark-Jan Boes ,
Feike C. Drost  and
Bas J. M. Werker
Mark-Jan Boes
Affiliation:
mboes@feweb.vu.nl, Finance Group, Free University Amsterdam, De Boelelaan 1105, 1081 HV, Amsterdam, The Netherlands
Feike C. Drost
Affiliation:
f.c.drost@uvt.nl, Econometrics and Finance Group, CentER, Tilburg University, P.O. Box 90153, 5000 LE, Tilburg, The Netherlands.
Bas J. M. Werker
Affiliation:
b.j.m.werker@uvt.nl, Econometrics and Finance Group, CentER, Tilburg University, P.O. Box 90153, 5000 LE, Tilburg, The Netherlands.
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Abstract

This paper investigates the effect of closed overnight exchanges on option prices. During the trading day, asset prices follow the literature's standard affine model that allows for stochastic volatility and random jumps. Independently, the overnight asset price process is modeled by a single jump. We find that the overnight component reduces the variation in the random jump process significantly. However, neither the random jumps nor the overnight jumps alone are able to empirically describe all features of option prices. We conclude that both random jumps during the day and overnight jumps are important in explaining option prices, where the latter account for about one quarter of total jump risk.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 2 , June 2007 , pp. 517 - 533
Copyright
Copyright © School of Business Administration, University of Washington 2007

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