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Implied risk aversion in option prices using Hermite polynomials

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  • Coutant, Sophie
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    Abstract

    The aim of this paper is to construct a time-varying estimator of the investors' risk aversion function. Jackwerth (1996) and Aït-Sahalia and Lo (1998) show that there exists a theoretical relationship between the Risk Neutral Density (RND), the Subjective Density (SD), and the Risk Aversion Function. The RND is estimated from options prices and the SD is estimated from underlying asset time series. Both densities are estimated on daily French data using Hermite polynomials' expansions as suggested first by Madan and Milne (1994). We then deduce an estimator of the Risk Aversion Function and show that it is time varying.

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    File URL: http://basepub.dauphine.fr/xmlui/bitstream/123456789/9842/1/cereg9908_COUTANT_Implied%20Risk%20Aversion%20in%20Options%20Prices%20Using%20Hermite%20Polynomials.pdf
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    Bibliographic Info

    Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/9842.

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    Date of creation: Jun 1999
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    Handle: RePEc:dau:papers:123456789/9842

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    Related research

    Keywords: Hermite polynomials; Statistical density; Risk neutral density; Index option's pricing; Risk aversion function;

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    Cited by:
    1. Marian Micu, 2005. "Extracting expectations from currency option prices: a comparison of methods," Computing in Economics and Finance 2005, Society for Computational Economics 226, Society for Computational Economics.
    2. Robert R Bliss & Nikolaos Panigirtzoglou, 2000. "Testing the stability of implied probability density functions," Bank of England working papers, Bank of England 114, Bank of England.
    3. Bliss, Robert R. & Panigirtzoglou, Nikolaos, 2002. "Testing the stability of implied probability density functions," Journal of Banking & Finance, Elsevier, Elsevier, vol. 26(2-3), pages 381-422, March.
    4. Kang, Byung Jin & Kim, Tong Suk, 2006. "Option-implied risk preferences: An extension to wider classes of utility functions," Journal of Financial Markets, Elsevier, Elsevier, vol. 9(2), pages 180-198, May.

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