Non-structural approach to implied moments extraction

Moments of future prices and returns are not observable, but it is possible to measure them indirectly. A set of option prices with the same maturity but with different exercise prices are used to extract implied probability distribution of the underlying asset at the expiration date. The aim is to...

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Bibliographic Details
Published in:Economic research - Ekonomska istraživanja 2018-01, Vol.31 (1), p.1923-1939
Main Authors: Šestanović, Tea, Arnerić, Josip, Aljinović, Zdravka
Format: Article
Language:English
Subjects:
Economic theory
Edgeworth expansions
Extraction
implied moments
mixture of two log-normals
Prices
Probability distribution
Securities prices
Shimko's model
Shimko’s mode
Stock market indexes
Structural models
Volatility
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Summary:Moments of future prices and returns are not observable, but it is possible to measure them indirectly. A set of option prices with the same maturity but with different exercise prices are used to extract implied probability distribution of the underlying asset at the expiration date. The aim is to obtain market expectations from options and to investigate which non-structural model for estimating implied probability distribution gives the best fit. Non-structural models assume that only dynamics in prices is known. Mixture of two log-normals (MLN), Edgeworth expansions and Shimko's model (representatives of parametric, semiparametric and nonparametric approaches respectively) are compared. Previous researches are inconclusive about the superiority of one approach over the others. This article contributes to finding which approach dominates. The best fit model is used to describe moments of the implied probability distribution. The sample covers one-year data for DAX index options. The results are compared through models and maturities. All models give better short-term forecasts. In pairwise comparison, MLN is superior to other approaches according to mean squared errors and Diebold-Mariano test in the observed period for DAX index options.
ISSN:1331-677X
1848-9664
DOI:10.1080/1331677X.2018.1530607