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Estimating state price densities by Hermite polynomials: theory and application to the Italian derivatives market

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Author Info
Paolo Guasoni () (Universita' di Pisa)
Abstract

We study the problem of extracting the state price densities from the market prices of listed options. Adapting a model of Madan and Milne to a multiple expiration setting, we present an estimation method for the risk-neutral probability at a moving horizon of fixed length. With the exception of volatility, all model parameters can be estimated by linear regression and their number can be chosen arbitrarily, depending on the size of the dataset. We discuss empirical issues related to the application of this model to real data and show results on listed options on the Italian MIB30 equity index.

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Paper provided by Bank of Italy, Economic Research Department in its series Temi di discussione (Economic working papers) with number 507.

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Date of creation: Jul 2004
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Handle: RePEc:bdi:wptemi:td_507_04

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Related research
Keywords: option pricing; state-price densities; orthogonal polynomials; risk-neutral valuation; calibration;

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July. [Downloadable!] (restricted)
  2. Guiso, Luigi & Parigi, Giuseppe, 1996. "Investment and Demand Uncertainty," CEPR Discussion Papers 1497, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Joshua Rosenberg & Robert F. Engle, 2000. "Empirical Pricing Kernels," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-014, New York University, Leonard N. Stern School of Business-. [Downloadable!]
    Other versions:
  4. Yacine Ait-Sahalia & Andrew W. Lo, 1995. "Nonparametric Estimation of State-Price Densities Implicit in Financial Asset Prices," NBER Working Papers 5351, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley. [Downloadable!]
  6. Frank Milne & Dilip Madan, 1994. "Contingent Claims Valued And Hedged By Pricing And Investing In A Basis," Working Papers 1158, Queen's University, Department of Economics. [Downloadable!]
    Other versions:
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