The performance of popular stochastic volatility option pricing models during the Subprime crisis

Petitjean, Mikael [FUCAM] Moyaert, Thibaut

We assess the performance of the Heston (1993), Bates (1996), and Heston and Nandi (2000) models against two benchmarks, i.e. the Black and Scholes model and a proprietary trading desk model. Using daily options prices on the Eurostoxx 50 stock index over the whole year 2008, we show that the most consistent in-sample and out-of-sample statistical performance is obtained for the internal model. However, the Bates model seems to be better suited to short term (out-of-the-money) options while the Heston model seems to perform better for medium or long term options. In terms of hedging performance, the Heston and Nandi model exhibits the best average, albeit most volatile, result and the Heston model outperforms the Black and Scholes model in terms of hedging errors, mainly for option contracts that mature in-the-money.