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Dynamics of state price densities

  • Härdle, Wolfgang
  • Hlávka, Zdenek

State price densities (SPDs) are an important element in applied quantitative finance. In a Black-Scholes world they are lognormal distributions, but in practice volatility changes and the distribution deviates from log-normality. In order to study the degree of this deviation, we estimate SPDs using EUREX option data on the DAX index via a nonparametric estimator of the second derivative of the (European) call pricing function. The estimator is constrained so as to satisfy no-arbitrage constraints and corrects for the intraday covariance structure in option prices. In contrast to existing methods, we do not use any parametric or smoothness assumptions.

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Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 150 (2009)
Issue (Month): 1 (May)
Pages: 1-15

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Handle: RePEc:eee:econom:v:150:y:2009:i:1:p:1-15
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