The empirical performance of option-based densities of foreign exchange
AbstractIn this paper, the authors calculate risk-neutral densities (RND) by estimating the daily diffusion process of the underlying futures contract for foreign exchange, based on the price of the American puts and calls reported on the Chicago Mercantile Exchange for the end of the day. Their quick and accurate method of calculating the prices of the American options uses higher-order lattices and smoothing of the option's value function at the boundaries to mitigate the nondifferentiability of the payoff boundary at expiration and the early exercise boundary. The authors estimate the diffusion process by minimizing the squared distance between the calculated prices and the observed prices in the data.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 0313.
Date of creation: 2003
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-01-18 (All new papers)
- NEP-CMP-2004-01-18 (Computational Economics)
- NEP-ETS-2004-01-18 (Econometric Time Series)
- NEP-FIN-2004-01-18 (Finance)
- NEP-FMK-2004-01-18 (Financial Markets)
- NEP-IFN-2004-01-18 (International Finance)
- NEP-RMG-2004-01-18 (Risk Management)
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- Figlewski, Stephen & Gao, Bin, 1999.
"The adaptive mesh model: a new approach to efficient option pricing,"
Journal of Financial Economics,
Elsevier, vol. 53(3), pages 313-351, September.
- Stephen Figlewski & Bin Gao, 1998. "The Adaptive Mesh Model: A New Approach to Efficient Option Pricing," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-032, New York University, Leonard N. Stern School of Business-.
- Clements, Michael P. & Smith, Jeremy, 2001. "Evaluating forecasts from SETAR models of exchange rates," Journal of International Money and Finance, Elsevier, vol. 20(1), pages 133-148, February.
- Diebold, Francis X & Gunther, Todd A & Tay, Anthony S, 1998. "Evaluating Density Forecasts with Applications to Financial Risk Management," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 863-83, November.
- Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-32, December.
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