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State price density estimation with an application to the recovery theorem

Author

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  • Sanford Anthony

    (University of Maryland, College Park, MD, USA)

Abstract

This article introduces a model to estimate the risk-neutral density of stock prices derived from option prices. To estimate a complete risk-neutral density, current estimation techniques use a single mathematical model to interpolate option prices on two dimensions: strike price and time-to-maturity. Instead, this model uses B-splines with at-the-money knots for the strike price interpolation and a mixed lognormal function that depends on the option expiration horizon for the time-to-maturity interpolation. The results of this “hybrid” methodology are significantly better than other risk-neutral density extrapolation methods when applied to the recovery theorem.

Suggested Citation

  • Sanford Anthony, 2023. "State price density estimation with an application to the recovery theorem," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 27(1), pages 97-115, February.
    • Handle: RePEc:bpj:sndecm:v:27:y:2023:i:1:p:97-115:n:4
    DOI: 10.1515/snde-2018-0090
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