Acta Oeconomica Pragensia 2008, 16(4):12-21 | DOI: 10.18267/j.aop.126

On Estimation of Volatility of Financial Time Series for Pricing Derivatives

Michal Černý
RNDr. Ing. Michal Černý, Ph.D.; Katedra ekonometrie, Vysoká škola ekonomická v Praze, cernym@vse.cz.

Estimation of volatility of financial time series plays a crucial role in pricing derivatives. Volatility is often estimated from historical data; however, it is well known that volatility varies in time. We propose a method to choose a suitable length of historical data to estimate contemporary volatility. The method is based on adaptation of a procedure used in statistical quality control - a hypothesis, that data contains a changepoint of volatility, is tested and if the test gives a positive answer, the changepoint is estimated. Then, a period of data where no changepoint is statistically significant is used to estimate contemporary volatility. The approach is illustrated on an analysis of CZK/EUR exchange rates.

Keywords: Derivative, Black-Scholes model, time series, volatility, changepoint
JEL classification: C12, C13, G12

Published: August 1, 2008  Show citation

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Černý, M. (2008). On Estimation of Volatility of Financial Time Series for Pricing Derivatives. Acta Oeconomica Pragensia, 16(4), 12-21. doi: 10.18267/j.aop.126
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