Bayesian Prediction, Entropy, and Option Pricingx

Frederick Foster and Charles H. Whiteman
Additional contact information
Charles H. Whiteman: Senior Associate Dean; Director, Economic Research Institute; and Stanley M. Howe Chair in Leadership, Tippie College of Business, The University of Iowa.

Australian Journal of Management, 2006, vol. 31, issue 2, 181-205

Abstract: This paper studies the performance of the Foster-Whiteman (1999) procedure for using a Bayesian predictive distribution for the future price of an asset to compute the price of a European option on that asset. A technical contribution of the paper is the description of a sequential importance sampling procedure for implementing an informative prior that reflects and rewards past option-pricing success. The risk-neutralization of the predictive distribution is accomplished by Stutzer's (1996) constrained KLIC-minimizing change of measure. The procedure is used in weekly pricing of July and November options on soybeans on the Chicago Board of Trade from 1993–1997, and produces option prices that mimic market prices much more closely than those of the Black model or those produced by risk-neutralizing a nonparametric predictive.

Keywords: BAYESIAN PREDICTION; ENTROPY; OPTION PRICING; COMMODITIES (search for similar items in EconPapers)
Date: 2006
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://journals.sagepub.com/doi/10.1177/031289620603100202 (text/html)

Related works:
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: https://EconPapers.repec.org/RePEc:sae:ausman:v:31:y:2006:i:2:p:181-205

DOI: 10.1177/031289620603100202

Access Statistics for this article

More articles in Australian Journal of Management from Australian School of Business
Bibliographic data for series maintained by SAGE Publications ().