Nonparametric Option Pricing under Shape Restrictions

Yacine Ait-Sahalia and Jefferson Duarte

No 8944, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Frequently, economic theory places shape restrictions on functional relationships between economic variables. This paper develops a method to constrain the values of the first and second derivatives of nonparametric locally polynomial estimators. We apply this technique to estimate the state price density (SPD), or risk-neutral density, implicit in the market prices of options. The option pricing function must be monotonic and convex. Simulations demonstrate that nonparametric estimates can be quite feasible in the small samples relevant for day-to-day option pricing, once appropriate theory-motivated shape restrictions are imposed. Using S&P500 option prices, we show that unconstrained nonparametric estimators violate the constraints during more than half the trading days in 1999, unlike the constrained estimator we propose.

JEL-codes: G12 C14 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-fmk
Date: 2002-05
Note: AP
View list of references

Downloads: (external link)
http://www.nber.org/papers/w8944.pdf (application/pdf)
Access to the full text is generally limited to series subscribers, however if the top level domain of the client browser is in a developing country or transition economy free access is provided. More information about subscriptions and free access is available at http://www.nber.org/wwphelp.html.

Related works:
Journal Article: Nonparametric option pricing under shape restrictions (2003)
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: http://EconPapers.repec.org/RePEc:nbr:nberwo:8944

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w8944
The price is Paper copy available by mail.

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc
Address: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Contact information at EDIRC.
Series data maintained by ().