Extracting market information from equity options with exponential Lévy processes

Frank Fabozzi (), Arturo Leccadito and Radu S. Tunaru

Journal of Economic Dynamics and Control, 2014, vol. 38, issue C, 125-141

Abstract: Lévy processes have been successfully applied in the modeling of financial assets. Useful information such as implied volatility, skewness, and risk-preferences can be derived from market option prices. In this paper, we advocate using Esscher conjugate Lévy processes to estimate risk-neutral and empirical densities. More specifically, we employ the exponential Meixner and NIG processes to calculate in closed form the pricing kernel in the equity market and then study the evolution of equity market behavior between 2002 and 2010. Our empirical analysis using S&P 500 options shows that the risk preferences of equity investors were signalling an anomaly in the market well before the subprime prime mortgage crisis (August 2007) and the crisis of confidence that followed, anticipating the downfall in equity markets in 2008, but then returning to normal levels in 2009.

Keywords: Risk-neutral density; Exponential Lévy processes; Pricing kernel; Relative risk-aversion coefficient (search for similar items in EconPapers)
JEL-codes: C15 C52 C54 G15 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:38:y:2014:i:c:p:125-141

DOI: 10.1016/j.jedc.2013.10.001

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