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Pricing Multivariate Contingent Claims Using Estimated Risk-neutral Density Functions

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  • Joshua Rosenberg

Abstract

Many asset price series exhibit time-varying volatility, jumps, and other features inconsistent with assumptions about the underlying price process made by standard multivariate contingent claims (MVCC) pricing models. This paper develops an interpolative technique for pricing MVCCs ' flexible NLS pricing ' that involves the estimation of a flexible multivariate risk-neutral density function implied by existing asset prices. As an application, the flexible NLS pricing technique is used to value several bivariate contingent claims dependent on foreign exchange rates in 1993 and 1994. The bivariate flexible risk-neutral density function more accurately prices existing options than the bivariate lognormal density implied by a multivariate geometric brownian motion. In addition, the bivariate contingent claims analyzed have substantially different prices using the two density functions suggesting flexible NLS pricing may improve accuracy over standard methods.
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  • Joshua Rosenberg, 1996. "Pricing Multivariate Contingent Claims Using Estimated Risk-neutral Density Functions," New York University, Leonard N. Stern School Finance Department Working Paper Seires 96-36, New York University, Leonard N. Stern School of Business-.
  • Handle: RePEc:fth:nystfi:96-36
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    Cited by:

    1. Bondarenko, Oleg, 2003. "Estimation of risk-neutral densities using positive convolution approximation," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 85-112.
    2. Christoffersen, Peter & Jacobs, Kris & Chang, Bo Young, 2013. "Forecasting with Option-Implied Information," Handbook of Economic Forecasting, Elsevier.
    3. van den Goorbergh, R.W.J. & Genest, C. & Werker, B.J.M., 2003. "Multivariate Option Pricing Using Dynamic Copula Models," Discussion Paper 2003-122, Tilburg University, Center for Economic Research.
    4. David Backus & Silverio Foresi & Liuren Wu, 2002. "Accouting for Biases in Black-Scholes," Finance 0207008, EconWPA.
    5. Foad Shokrollahi, 2017. "Fractional delta hedging strategy for pricing currency options with transaction costs," Papers 1702.00037, arXiv.org.
    6. van den Goorbergh, Rob W.J. & Genest, Christian & Werker, Bas J.M., 2005. "Bivariate option pricing using dynamic copula models," Insurance: Mathematics and Economics, Elsevier, vol. 37(1), pages 101-114, August.
    7. van den Goorbergh, R.W.J., 2004. "Essays on optimal hedging and investment strategies and on derivative pricing," Other publications TiSEM 4b4b16af-8621-463f-bbfa-0, Tilburg University, School of Economics and Management.
    8. Joshua V. Rosenberg, 2003. "Nonparametric pricing of multivariate contingent claims," Staff Reports 162, Federal Reserve Bank of New York.
    9. Carluccio Bianchi & Alessandro Carta & Dean Fantazzini & Maria Elena De Giuli & Mario Maggi, 2010. "A copula-VAR-X approach for industrial production modelling and forecasting," Applied Economics, Taylor & Francis Journals, vol. 42(25), pages 3267-3277.
    10. Joshua V. Rosenberg & Robert F. Engle, 1997. "Option Hedging Using Empirical Pricing Kernels," NBER Working Papers 6222, National Bureau of Economic Research, Inc.
    11. Rob van den Goorbergh, 2004. "A Copula-Based Autoregressive Conditional Dependence Model of International Stock Markets," DNB Working Papers 022, Netherlands Central Bank, Research Department.
    12. Xiao, Wei-Lin & Zhang, Wei-Guo & Zhang, Xi-Li & Wang, Ying-Luo, 2010. "Pricing currency options in a fractional Brownian motion with jumps," Economic Modelling, Elsevier, vol. 27(5), pages 935-942, September.
    13. Fantazzini, Dean, 2010. "Three-stage semi-parametric estimation of T-copulas: Asymptotics, finite-sample properties and computational aspects," Computational Statistics & Data Analysis, Elsevier, vol. 54(11), pages 2562-2579, November.
    14. Joshua Rosenberg, 1999. "Semiparametric Pricing of Multivariate Contingent Claims," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-028, New York University, Leonard N. Stern School of Business-.
    15. Vladimir Zdorovenin & Jacques Pézier, 2011. "Does Information Content of Option Prices Add Value for Asset Allocation?," ICMA Centre Discussion Papers in Finance icma-dp2011-03, Henley Business School, Reading University.
    16. Nikkinen, Jussi, 2003. "Normality tests of option-implied risk-neutral densities: evidence from the small Finnish market," International Review of Financial Analysis, Elsevier, vol. 12(2), pages 99-116.
    17. Lim, G.C. & Martin, G.M. & Martin, V.L., 2006. "Pricing currency options in the presence of time-varying volatility and non-normalities," Journal of Multinational Financial Management, Elsevier, vol. 16(3), pages 291-314, July.
    18. Taboga, Marco, 2016. "Option-implied probability distributions: How reliable? How jagged?," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 453-469.

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