State price density estimation with an application to the recovery theorem

Sanford Anthony ()
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Sanford Anthony: University of Maryland, College Park, MD, USA

Studies in Nonlinear Dynamics & Econometrics, 2023, vol. 27, issue 1, 97-115

Abstract: This article introduces a model to estimate the risk-neutral density of stock prices derived from option prices. To estimate a complete risk-neutral density, current estimation techniques use a single mathematical model to interpolate option prices on two dimensions: strike price and time-to-maturity. Instead, this model uses B-splines with at-the-money knots for the strike price interpolation and a mixed lognormal function that depends on the option expiration horizon for the time-to-maturity interpolation. The results of this “hybrid” methodology are significantly better than other risk-neutral density extrapolation methods when applied to the recovery theorem.

Keywords: contingent state pricing; implied probabilities; recovery theorem; risk neutral density (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1515/snde-2018-0090

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