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State price density estimation with an application to the recovery theorem

  • Anthony Sanford ORCID logo EMAIL logo
Published/Copyright: August 9, 2021
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Studies in Nonlinear Dynamics & Econometrics
From the journal Studies in Nonlinear Dynamics & Econometrics Volume 27 Issue 1

Abstract

This article introduces a model to estimate the risk-neutral density of stock prices derived from option prices. To estimate a complete risk-neutral density, current estimation techniques use a single mathematical model to interpolate option prices on two dimensions: strike price and time-to-maturity. Instead, this model uses B-splines with at-the-money knots for the strike price interpolation and a mixed lognormal function that depends on the option expiration horizon for the time-to-maturity interpolation. The results of this “hybrid” methodology are significantly better than other risk-neutral density extrapolation methods when applied to the recovery theorem.

Keywords: contingent state pricing; implied probabilities; recovery theorem; risk neutral density
Corresponding author: Anthony Sanford, University of Maryland, College Park, MD, USA, E-mail:

  1. Author contribution: The author has accepted responsibility for the entire content of this submitted manuscript and approved submission.

  2. Research funding: None declared.

  3. Conflict of interest statement: The author declares no conflicts of interest regarding this article.

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Supplementary Material

The online version of this article offers supplementary material (https://doi.org/10.1515/snde-2018-0090).

Received: 2018-09-05
Revised: 2021-07-13
Accepted: 2021-07-24
Published Online: 2021-08-09

© 2021 Walter de Gruyter GmbH, Berlin/Boston

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  2. Research Articles
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  5. Bidirectional volatility transmission between stocks and bond in East Asia – The quantile estimates based on wavelets
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  8. State price density estimation with an application to the recovery theorem
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https://doi.org/10.1515/snde-2018-0090
Keywords for this article
contingent state pricing; implied probabilities; recovery theorem; risk neutral density

Articles in the same Issue

  1. Frontmatter
  2. Research Articles
  3. Estimation and forecasting of long memory stochastic volatility models
  4. Uncertainty and realized jumps in the pound-dollar exchange rate: evidence from over one century of data
  5. Bidirectional volatility transmission between stocks and bond in East Asia – The quantile estimates based on wavelets
  6. A threshold model for the spread
  7. A Gini estimator for regression with autocorrelated errors
  8. State price density estimation with an application to the recovery theorem
  9. Testing for random coefficient autoregressive and stochastic unit root models
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