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Dynamics of state price densities

[journal article]

Härdle, Wolfgang; Hlávka, Zdeněk

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Abstract State price densities (SPDs) are an important element in applied quantitative finance. In a Black-Scholes world they are lognormal distributions but in practice volatility changes and the distribution deviates from log-normality. In order to study the degree of this deviation, we estimate SPDs using EUREX option data on the DAX index via a nonparametric estimator of the second derivative of the (European) call pricing function. The estimator is constrained so as to satisfy no-arbitrage constraints and corrects for the intraday covariance structure in option prices. In contrast to existing methods, we do not use any parametric or smoothness assumptions.
Classification Economic Statistics, Econometrics, Business Informatics
Free Keywords Option pricing; State price density; Nonlinear least squares; Constrained estimation; JEL Classification: C13; C14; G13
Document language English
Publication Year 2009
Page/Pages p. 1-15
Journal Journal of Econometrics, 150 (2009) 1
Status Postprint; peer reviewed
Licence PEER Licence Agreement (applicable only to documents from PEER project)