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A Simple Nonparametric Approach to Derivative Security Valuation

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Author Info
 Stutzer, Michael
Abstract

Canonical valuation uses historical time series to predict the probability distribution of the discounted value of primary assets' discounted prices plus accumulated dividends at any future date. Then the axiomatically rationalized maximum entropy principle is used to estimate risk-neutral (equivalent martingale) probabilities that correctly price the primary assets, as well as any predesignated subset of derivative securities whose payoffs occur at this date. Valuation of other derivative securities proceeds by calculation of its discounted, risk-neutral expected value. Both simulation and empirical evidence suggest that canonical valuation has merit. Copyright 1996 by American Finance Association.

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Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 51 (1996)
Issue (Month): 5 (December)
Pages: 1633-52
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Handle: RePEc:bla:jfinan:v:51:y:1996:i:5:p:1633-52

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  3. Ramaprasad Bhar, Carl Chiarella, 2000. "Expectations of monetary policy in Australia implied by the probability distribution of interest rate derivatives," European Journal of Finance, Taylor and Francis Journals, vol. 6(2), pages 113-125, June. [Downloadable!] (restricted)
  4. Joshua Rosenberg, 2000. "Asset Pricing Puzzles: Evidence from Options Markets," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-025, New York University, Leonard N. Stern School of Business-. [Downloadable!]
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  6. Marie Brière, 2006. "Market Reactions to Central Bank Communication Policies : Reading Interest Rate Options Smiles," Working Papers CEB 06-009.RS, Université Libre de Bruxelles, Solvay Business School, Centre Emile Bernheim (CEB). [Downloadable!]
  7. Rama CONT, 1998. "Beyond implied volatility: extracting information from option prices," Finance 9804002, EconWPA. [Downloadable!]
  8. Vladislav Kargin, 2003. "Consistent Estimation of Pricing Kernels from Noisy Price Data," Finance 0311001, EconWPA. [Downloadable!]
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  10. Yacine Ait-Sahalia & Andrew W. Lo, 2000. "Nonparametric Risk Management and Implied Risk Aversion," NBER Working Papers 6130, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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