Revealing the Implied Risk-neutral MGF with the Wavelet Method

Emmanuel Haven, Xiaoquan Liu, Chenghu Ma and Liya Shen

No 2013-10-14, Working Papers from Wang Yanan Institute for Studies in Economics (WISE), Xiamen University

Abstract: Options are believed to contain unique information about the risk- neutral moment generating function (MGF hereafter) or the risk-neutral probability density function (PDF hereafter). This paper applies the wavelet method to approximate the risk-neutral MGF of the under- lying asset from option prices. Monte Carlo simulation experiments are performed to elaborate how the risk-neutral MGF can be obtained using the wavelet method. The Black-Scholes model is chosen as the benchmark model. We offer a novel method for obtaining the implied risk-neutral MGF for pricing out-of-sample options and other complex or illiquid derivative claims on the underlying asset using information obtained from simulated data.

Keywords: Implied risk-neutral MGF; wavelets; options; Black-Scholes model. (search for similar items in EconPapers)
Date: 2013-10-14
New Economics Papers: this item is included in nep-rmg
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