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Evaluating Implied RNDs by some New Confidence Interval Estimation Techniques

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  • Andersson, Magnus

    ()
    (European Central Bank)

  • Lomakka, Magnus

    ()
    (AP-fund 1)

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    Abstract

    This paper evaluates the precision of the parametric double lognormal (DLN) and the nonparametric smoothing spline method (SPLINE) for estimating risk-neutral distributions (RNDs) from observed option prices. By using a bootstrap technique confidence bands are estimated for the riskneutral distributions (RNDs) and the width is used as the criterion when evaluating the precision of the two. Previous literature on estimating confidence bands has to a large extent been estimated by Monte Carlo methods. We argue that the bootstrap technique is to be preferred due to the non-normality of the error structure. Our findings favour the SPLINE method, yielding tighter confidence bands. An example showing how the confidence intervals could be used for practical purposes is also provided.

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    Bibliographic Info

    Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 146.

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    Length: 24 pages
    Date of creation: 01 Jan 2003
    Date of revision:
    Publication status: Published in Journal of Banking & Finance, 2005, pages 1535-1557.
    Handle: RePEc:hhs:rbnkwp:0146

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    Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
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    Related research

    Keywords: Implied risk-neutral distribution; confidence intervals; bootstrap;

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    1. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-51, October.
    2. Robert R. Bliss & Nikolaos Panigirtzoglou, 2001. "Recovering risk aversion from options," Working Paper Series WP-01-15, Federal Reserve Bank of Chicago.
    3. Ritchey, Robert J, 1990. "Call Option Valuation for Discrete Normal Mixtures," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 13(4), pages 285-96, Winter.
    4. Melick, William R. & Thomas, Charles P., 1997. "Recovering an Asset's Implied PDF from Option Prices: An Application to Crude Oil during the Gulf Crisis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(01), pages 91-115, March.
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