Discussion Papers, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes 1999,58
Daily returns of financial assets are frequently found to exhibit positive autocorrelation at lag 1. When specifying a linear AR(l) conditional mean, one may ask how this predictability affects option prices. We investigate the dependence of option prices on autoregressive dynamics under stylized facts of stock returns, i.e., conditional heteroskedasticity: leverage effect, and conditional leptokurtosis. Our analysis covers both a continuous and discrete time framework. The results suggest that a non-zero autoregression coefficient tends to increase the deviation of option prices from Black & Scholes prices caused by stochastic volatility.