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Nonparametric pricing of multivariate contingent claims

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  • Joshua V. Rosenberg

Abstract

In this paper, I derive and implement a nonparametric, arbitrage-free technique for multivariate contingent claim (MVCC) pricing. Using results from the method of copulas, I show that the multivariate risk-neutral density can be written as a product of marginal risk-neutral densities and a risk-neutral dependence function. I then develop a pricing technique using nonparametrically estimated marginal risk-neutral densities (based on options data) and a nonparametric dependence function (based on historical return data). By using nonparametric estimation, I avoid the pricing biases that result from incorrect parametric assumptions such as lognormality. ; I apply this technique to estimate the joint risk-neutral density of euro-dollar and yen-dollar returns. I compare the nonparametric risk-neutral density with density based on a lognormal dependence function and nonparametric marginals. The nonparametric euro-yen risk-neutral density has greater volatility, skewness, and kurtosis than the density based on a lognormal dependence function. In a comparison of pricing accuracy for euro-yen futures options, I find that the nonparametric model is superior to the lognormal model.

Suggested Citation

  • Joshua V. Rosenberg, 2003. "Nonparametric pricing of multivariate contingent claims," Staff Reports 162, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:162
    Note: For a published version of this report, see Joshua V. Rosenberg, "Non-parametric Pricing of Multivariate Contingent Claims," Journal of Derivatives 10, no. 3 (spring 2003): 9-26.
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    More about this item

    Keywords

    asset pricing; estimation theory; Eurodollar market; Japanese yen;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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