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Reading the Smile: The Message Conveyed by Methods Which Infer Risk Neutral

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  • Jondeau, E.
  • Rockinger, M.

Abstract

In this study we compare the quality and information content of risk neutral densities obtained by various methods. We consider a non-parametric method based on a mixture of log-normal densities, the semi-parametric ones based on an Hermite approximation of Madan and Milne, or based on an Edgeworth expansion of Jarrow and Rudd, the parametric approach of Malz which assumes a jump-diffusion for the underlying process, and eventually Heston's approach assuming a stochastic volatility model. We apply those models on FRF/DEM exchange rate options for two dates, for various maturities. Models differ when important news hit the market (here the 1997 snap elections). The non-parametric model provides a good fit to options prices but is unable under critical circumstances to provide as much information about market participants expectations than Malz's jump-diffusion model.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 47.

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Length: 27 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:bfr:banfra:47

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Related research

Keywords: Risk neutral density ; Option pricing ; Exchange rate option.;

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References

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Citations

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Cited by:
  1. E, Clement & Christian Gourieroux & Alain Monfort, 1997. "Econometric Specification of the Risk Neutral Valuation Model," Working Papers 97-33, Centre de Recherche en Economie et Statistique.
  2. Maria Grith & Volker Krätschmer, 2010. "Parametric estimation of risk neutral density functions," SFB 649 Discussion Papers SFB649DP2010-045, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  3. Rihab Bedoui & Haykel Hamdi, 2010. "Implied Risk-Neutral probability Density functions from options prices : A comparison of estimation methods," EconomiX Working Papers 2010-16, University of Paris West - Nanterre la Défense, EconomiX.
  4. Jondeau, E. & Rockinger, M., 1998. "Estimating Gram-Charlier Expansions with Positivity Constraints," Working papers 56, Banque de France.

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