 Parametric risk-neutral density estimation via finite lognormal-Weibull mixturesYifan Li, Ingmar Nolte and Manh Cuong Pham Journal of Econometrics, 2024, vol. 241, issue 2 Abstract: This paper proposes a new parametric risk-neutral density (RND) estimator based on a finite lognormal-Weibull mixture (LWM) density. We establish the consistency and asymptotic normality of the LWM method in a general misspecified parametric framework. Based on the theoretical results, we propose a sequential test procedure to evaluate the goodness-of-fit of the LWM model, which leads to an adaptive choice for the number and type of mixture components. Our simulation results show that, in finite samples with various observation error specifications, the LWM method can approximate complex RNDs generated by state-of-the-art multi-factor stochastic volatility models with a few (typically less than 4) mixtures. Application of the LWM model on index options confirms its reliability in recovering empirical RNDs with a heavy left tail or bimodality, which can be incorrectly identified as bimodality or a heavy left tail by existing (semi)-nonparametric methods if the goodness-of-fit to the observed data is ignored. Keywords: Risk-neutral density; Parametric modelling; Mixture-of-distribution method (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:241:y:2024:i:2:s0304407624000940 DOI: 10.1016/j.jeconom.2024.105748 Access Statistics for this article Journal of Econometrics is currently edited by T. Amemiya, A. R. Gallant, J. F. Geweke, C. Hsiao and P. M. Robinson More articles in Journal of Econometrics from Elsevier |
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