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Revealing the implied risk-neutral MGF from options: The wavelet method

  • Haven, Emmanuel
  • Liu, Xiaoquan
  • Ma, Chenghu
  • Shen, Liya
Registered author(s):

    Options are believed to contain unique information on the risk-neutral moment generating function (MGF) or the risk-neutral probability density function (PDF) of the underlying asset. This paper applies the wavelet method to approximate the implied risk-neutral MGF from option prices. Monte Carlo simulations are carried out to show how the risk-neutral MGF can be obtained using the wavelet method. With the Black-Scholes model as the benchmark, we offer a novel method to reveal the implied MGF, and to price in-sample options and forecast out-of-sample option prices with the estimated MGF.

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    Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

    Volume (Year): 33 (2009)
    Issue (Month): 3 (March)
    Pages: 692-709

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    Handle: RePEc:eee:dyncon:v:33:y:2009:i:3:p:692-709
    Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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