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The forecast ability of risk-neutral densities of foreign exchange

  • Craig, Ben R.
  • Keller, Joachim

We estimate the process underlying the pricing of American options by using higher-order lattices combined with a multigrid method. This paper also tests whether the risk-neutral densities given from American options provide a good forecasting tool. We use a nonparametric test of the densities that is based on the inverse probability functions and is modified to account for correlation across time between our random variables, which are uniform under the null hypothesis. We find that the densities based on the Americanoption markets for foreign exchange do quite well for the forecasting period over which the options are thickly traded. Further, simple models that fit the densities do about as well as more sophisticated models.

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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2005,05.

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Date of creation: 2005
Date of revision:
Handle: RePEc:zbw:bubdp2:4260
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  1. Falko Fecht & Kevin Huang & Antoine Martin, 2004. "Financial intermediaries, markets, and growth," Research Working Paper RWP 04-02, Federal Reserve Bank of Kansas City.
  2. Hamerle, Alfred & Liebig, Thilo & Scheule, Harald, 2004. "Forecasting Credit Portfolio Risk," Discussion Paper Series 2: Banking and Financial Studies 2004,01, Deutsche Bundesbank, Research Centre.
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