Modelling the implied probability of stock market movements
AbstractIn this paper we study risk-neutral densities (RNDs) for the German stock market. The use of option prices allows us to quantify the risk-neutral probabilities of various levels of the DAX index. For the period from December 1995 to November 2001, we implement the mixture of log-normals model and a volatility-smoothing method. We discuss the time series behaviour of the implied PDFs and we examine the relations between the moments and observable factors such as macroeconomic variables, the US stock markets and credit risk. We find that the risk-neutral densities exhibit pronounced negative skewness. Our second main observation is a significant spillover of volatility, as the implied volatility and kurtosis of the DAX RND are mostly driven by the volatility of US stock prices. JEL Classification: C22, C51, G13, G15
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Find related papers by JEL classification:
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models &bull Diffusion Processes
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
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