Alternative Tilts for Nonparametric Option Pricing

Todd Walker and M. Ryan Haley

MPRA Paper from University Library of Munich, Germany

Abstract: This paper generalizes the nonparametric approach to option pricing of Stutzer (1996) by demonstrating that the canonical valuation methodology in- troduced therein is one member of the Cressie-Read family of divergence mea- sures. While the limiting distribution of the alternative measures is identical to the canonical measure, the finite sample properties are quite different. We assess the ability of the alternative divergence measures to price European call options by approximating the risk-neutral, equivalent martingale measure from an empirical distribution of the underlying asset. A simulation study of the finite sample properties of the alternative measure changes reveals that the optimal divergence measure depends upon how accurately the empirical distri- bution of the underlying asset is estimated. In a simple Black-Scholes model, the optimal measure change is contingent upon the number of outliers observed, whereas the optimal measure change is a function of time to expiration in the stochastic volatility model of Heston (1993). Our extension of Stutzer’s tech- nique preserves the clean analytic structure of imposing moment restrictions to price options, yet demonstrates that the nonparametric approach is even more general in pricing options than originally believed.

Keywords: Option Pricing; Nonparametric; Entropy (search for similar items in EconPapers)
JEL-codes: C14 G13 (search for similar items in EconPapers)
Date: 2009-09-06
New Economics Papers: this item is included in nep-bec, nep-cfn and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/17140/1/MPRA_paper_17140.pdf original version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:17140

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().