Option pricing with the efficient method of moments

While the stochastic volatility (SV) generalization has been shown to improve the explanatory power over the Black-Scholes model, empirical implications of SV models on option pricing have not yet been adequately tested. The purpose of this paper is to investigate the respective effect of stochastic interest rates, systematic volatility and idiosyncratic volatility on option prices. We compute option prices using reprojected underlying historical volatilities and implied stochastic volatility risk to gauge each model's performance through direct comparison with observed market option prices.