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A multi-horizon comparison of density forecasts for the S&P 500 using index returns and option prices

  • Shackleton, Mark B.
  • Taylor, Stephen J.
  • Yu, Peng

We compare density forecasts of the S&P 500 index from 1991 to 2004, obtained from option prices and daily and 5-min index returns. Risk-neutral densities are given by using option prices to estimate diffusion and jump-diffusion processes which incorporate stochastic volatility. Three transformations are then used to obtain real-world densities. These densities are compared with historical densities defined by ARCH models. For horizons of two and four weeks the best forecasts are obtained from risk-transformations of the risk-neutral densities, while the historical forecasts are superior for the one-day horizon; our ranking criterion is the out-of-sample likelihood of observed index levels. Mixtures of the real-world and historical densities have higher likelihoods than both components for short forecast horizons.

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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 34 (2010)
Issue (Month): 11 (November)
Pages: 2678-2693

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Handle: RePEc:eee:jbfina:v:34:y:2010:i:11:p:2678-2693
Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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