An Option Pricing Formula for the GARCH diffusion model

Giovanni Barone-Adesi, Henrik Rasmussen and Claudia Ravanelli

Abstract

We derive analytically the first four conditional moments of the integrated variance implied by the GARCH diffusion process. From these moments we obtain an analytical closed-form approximation formula to price European options under the GARCH diffusion model. Using Monte Carlo simulations, we show that this approximation formula is accurate for a large set of reasonable parameters. Finally, we use the closed-form option pricing solution to shed light on the qualitative properties of implied volatility surfaces induced by GARCH diffusion models.