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Reading the smile: the message conveyed by methods which infer risk neutral densities

  • Jondeau, Eric
  • Rockinger, Michael

In this study, we compare the quality and information content of risk neutral densities obtained by various methods. We consider a non-parametric method based on a mixture of log-normal densities, the semi-parametric ones based on an Hermite approximation or based on an Edgeworth expansion, the parametric approach of Malz which assumes a jump-diffusion for the underlying process, and Heston's approach assuming a stochastic volatility model. We apply those models on FF/DM exchange rate options for two dates. Models differ when important news hits the market (here anticipated elections). The non-parametric model provides a good fit to options prices but is unable to provide as much information about market participants expectations than the jump-diffusion model.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 19 (2000)
Issue (Month): 6 (December)
Pages: 885-915

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Handle: RePEc:eee:jimfin:v:19:y:2000:i:6:p:885-915
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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