time series methods and derivative pricing methods

[vkaul]

I wanted to see where each of these methods are used and where they crisscross. For example, I heard that derivative pricing does not concern itself with future prediction like time series does, but perhaps it can use volatility information from GARCH models. Is it true that the field of derivative pricing is short term hedging, while time series is long-term arbitrage. I will appreciate is somebody points out the relations between the two approaches and where both are used simultaneously.

 

[quantstart]

Have you had a look at this page on Wikipedia? It talks about different volatility models utilised in the Black-Scholes model:
Stochastic volatility - Wikipedia, the free encyclopedia

 

[Sanket Patel]

I wanted to see where each of these methods are used and where they crisscross. For example, I heard that derivative pricing does not concern itself with future prediction like time series does, but perhaps it can use volatility information from GARCH models. Is it true that the field of derivative pricing is short term hedging, while time series is long-term arbitrage. I will appreciate is somebody points out the relations between the two approaches and where both are used simultaneously.

You may find the attached PDF useful.

 

[quantstart]

I was aware of the volatility models (Jump-Diffusion and, obviously, GBM), but the mean-reversion sections are new to me. Very interesting! Thanks Sanket.

 

[HyperVolatility]

An edge over the crowd can be earned if you price a derivative better than someone else. this is particularly true for options where the volatility forecasting is a crucial factor for traders.

the BSM model is quite obsolete and you should look at asymmetric GARCH models, Heston model or the Chen model if you really want to understand how to use volatility.