• Media type: E-Book; Report
  • Title: Extracting risk neutral probability densities by fitting implied volatility smiles: Some methodological points and an application to the 3M Euribor futures option prices
  • Contributor: Andersen, Allan Bødskov [Author]; Wagener, Tom [Author]
  • imprint: Copenhagen: Danmarks Nationalbank, 2002
  • Language: English
  • Keywords: Zinsderivat ; Theorie ; interest rate expectation ; Volatilität ; C14 ; Optionspreistheorie ; F33 ; Risikoneutralität ; G15 ; Implied volatility ; risk neutral density estimation
  • Origination:
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  • Description: Following Shimko (1993), a large amount of research has evolved around the problem of extracting risk neutral densities from options prices by interpolating the Black-Scholes implied volatility smile. Some of the methods recently proposed use variants of the cubic spline. These methods have the property of producing non-differentiable probability densities. We argue that this is an undesirable feature and suggest circumventing the problem by fitting a smoothing spline of higher order polynomials with a relatively low number of knot points. In the estimations we opt for a measure of roughness penalty, which is more appropriate than the plain second partial derivative often used. We apply this technique to the LIFFE three-month Euribor futures option prices. Constant horizon risk neutral densities are calculated and summary statistics from these densities are used to assess market uncertainty on a day-by-day basis. Finally, we analyse the impact of the 11 September attacks on the expectation of future Euribor interest rates.
  • Access State: Open Access