A Semiparametric Estimation of Liquidity Effects on Option Pricing

María Eva Ferreira García, Mónica Gago and Gonzalo Rubio Irigoyen

No 1134-8984, BILTOKI from Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística)

Abstract: This paper proposes a semiparametric option pricing model with liquidity, as proxied by the relative bid-ask spread. The nonparametric volatility function with liquidity as an explanatory variable is estimated using the Symmetrized Nearest Neighbors (SNN) estimator rather than the traditional kernel estimator. Moreover, special care is taken in obtaining the smoothing parameter. The in-sample performance of the model turns out to be statistically favorable relative to a competing model without liquidity. However, the out-of-sample performance of both models is quite disappointing despite the fact that we are not to reject the stability of risk-neutral densities estimated over different quarters during our sample period.

Keywords: multivariate kernel regression; bandwidth selection; symmetrized nearest neighbors; volatility smile; option pricing (search for similar items in EconPapers)
Date: 1999-09
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Persistent link: https://EconPapers.repec.org/RePEc:ehu:biltok:5903

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Dpto. de Econometría y Estadística, Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain

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