Distributions Implied by Exchange Traded Options: A Ghost’s Smile?
A new and easily applicable method for estimating risk neutral distributions (RND) implied by American futures options is proposed. It amounts to inverting the Barone-Adesi and Whaley method (1987) (BAW method) to get the BAW-implied volatility smile. Extensive empirical tests show that the BAW smile is equivalent to the volatility smile implied by corresponding European options. Therefore, the procedure leads to a legitimate RND estimation method. Further, the investigation of the currency options traded on the Chicago Mercantile Exchange and OTC markets in parallel provides us with insights on the structure and interaction of the two markets. Unequally distributed liquidity in the OTC market seems to lead to price distortions and an ensuing interesting `ghost- like' shape of the RND density implied by CME options. Finally, using the empirical results, we propose a parsimonious generalisation of the existing methods for estimating volatility smiles from OTC options. A single free parameter significantly improves the fit. Note:The revised version of this paper was published as: Cincibuch, M., 2004. Distributions Implied by American Currency Futures Options: A Ghosts' Smile ? Journal of Futures Markets, 2004, 24(2).
|Date of creation:||Oct 2002|
|Contact details of provider:|| Postal: P.O. Box 882, Politickych veznu 7, 111 21 Praha 1|
Phone: (+420) 224 005 123
Fax: (+420) 224 005 333
Web page: http://www.cerge-ei.cz
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Pavel Bouc & Martin Cincibuch, 2004. "An Interpretation of Czech FX Options," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 54(7-8), pages 286-304, July.
- Robert R Bliss & Nikolaos Panigirtzoglou, 2000. "Testing the stability of implied probability density functions," Bank of England working papers 114, Bank of England.
- Soderlind, Paul & Svensson, Lars, 1997.
"New techniques to extract market expectations from financial instruments,"
Journal of Monetary Economics,
Elsevier, vol. 40(2), pages 383-429, October.
- Soderlind, P & Svensson, L-E-O, 1996. "New Techniques to Extract Market Expectations from Financial Instruments," Papers 621, Stockholm - International Economic Studies.
- Söderlind, Paul & Svensson, Lars E.O., 1996. "New Techniques to Extract Market expectations from Financial Instruments," SSE/EFI Working Paper Series in Economics and Finance 142, Stockholm School of Economics.
- Söderlind, Paul & Svensson, Lars E O, 1997. "New Techniques to Extract Market Expectations from Financial Instruments," CEPR Discussion Papers 1556, C.E.P.R. Discussion Papers.
- Paul Soderlind & Lars E. O. Svensson, 1997. "New Techniques to Extract Market Expectations from Financial Instruments," NBER Working Papers 5877, National Bureau of Economic Research, Inc.
- Söderlind, Paul & Svensson, Lars E.O., 1997. "New Techniques to Extract Market Expectations from Financial Instruments," Seminar Papers 621, Stockholm University, Institute for International Economic Studies.
- 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 621-651, October.
- Buchen, Peter W. & Kelly, Michael, 1996. "The Maximum Entropy Distribution of an Asset Inferred from Option Prices," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(01), pages 143-159, March.
- Bruce D. Grundy, "undated". "Option Prices and the Underlying Asset's Return Distribution (Reprint 012)," Rodney L. White Center for Financial Research Working Papers 11-91, Wharton School Rodney L. White Center for Financial Research.
- Jose M. Campa & P.H. Kevin Chang & Robert L. Reider, 1997. "Implied Exchange Rate Distributions: Evidence from OTC Option Markets," NBER Working Papers 6179, National Bureau of Economic Research, Inc.
- Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
- Jorion, Philippe, 1995. " Predicting Volatility in the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 50(2), pages 507-528, June.
- Whaley, Robert E, 1986. " Valuation of American Futures Options: Theory and Empirical Tests," Journal of Finance, American Finance Association, vol. 41(1), pages 127-150, March.
- 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.
- Danielsson, Jon, 2002. "The emperor has no clothes: Limits to risk modelling," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1273-1296, July.
- Jon Danielsson, 2000. "The Emperor has no Clothes: Limits to Risk Modelling," FMG Special Papers sp126, Financial Markets Group.
- Grundy, Bruce D, 1991. " Option Prices and the Underlying Asset's Return Distribution," Journal of Finance, American Finance Association, vol. 46(3), pages 1045-1069, July.
- Broadie, Mark & Detemple, Jerome, 1996. "American Option Valuation: New Bounds, Approximations, and a Comparison of Existing Methods," Review of Financial Studies, Society for Financial Studies, vol. 9(4), pages 1211-1250.
- Cox, John C. & Ingersoll, Jonathan Jr. & Ross, Stephen A., 1981. "The relation between forward prices and futures prices," Journal of Financial Economics, Elsevier, vol. 9(4), pages 321-346, December.
- Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-1632, December.
- Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
- Bhupinder Bahra, 1997. "Implied risk-neutral probability density functions from option prices: theory and application," Bank of England working papers 66, Bank of England.
- Christensen, B. J. & Prabhala, N. R., 1998. "The relation between implied and realized volatility," Journal of Financial Economics, Elsevier, vol. 50(2), pages 125-150, November.
- Dong-Hyun Ahn & Jacob Boudoukh & Matthew Richardson & Robert F. Whitelaw, 1999. "Optimal Risk Management Using Options," Journal of Finance, American Finance Association, vol. 54(1), pages 359-375, 02.
- Grundy, R.D., 1991. "Option Prices and the Underlying Asset's Return Distribution," Weiss Center Working Papers 11-91, Wharton School - Weiss Center for International Financial Research. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:cer:papers:wp200. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jana Koudelkova)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.