Pricing and hedging long-term options

Do long-term and short-term options contain differential information? If so , can long-term options better differentiate among alternative models? To a nswer these questions, we first demonstrate analytically that differences a mong alternative models usually may not surface when applied to short-term options, but do so when applied to longterm contracts. Using S&P 500 option s and LEAPS, we find that short- and long-term contracts indeed contain dif ferent information. While the data suggest little gains from modeling stoch astic interest rates or random jumps (beyond stochastic volatility) for pri cing LEAPS, incorporating stochastic interest rates can nonetheless enhance hedging performance in certain cases involving long-term contracts. (C) 20 00 Elsevier Science S.A. All rights reserved. classification: G10; G12; G13 .