Option pricing with maximum entropy densities: The inclusion of higher‐order moments

Omid Ardakani

Journal of Futures Markets, 2022, vol. 42, issue 10, 1821-1836

Abstract: Entropy pricing applies notions of information theory to derive the theoretical value of options. This paper employs the maximum entropy (ME) formulation of option pricing, given risk‐neutral moment constraints computed directly from the observed prices. First, higher‐order moments are used to generate option prices. Then a generalization of Shannon entropy, known as Renyi entropy, is studied to account for extreme events. This ME problem provides a class of heavy‐tailed distributions. Examples and Monte Carlo simulations are provided to examine the effects of moment constraints on option prices. The call option values are then constructed using daily Standard and Poor's 500 index options. The findings suggest that entropy pricing with higher‐order moment constraints provides higher forecasting accuracy.

Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
https://doi.org/10.1002/fut.22361

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:wly:jfutmk:v:42:y:2022:i:10:p:1821-1836

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=0270-7314

Access Statistics for this article

Journal of Futures Markets is currently edited by Robert I. Webb

More articles in Journal of Futures Markets from John Wiley & Sons, Ltd.
Bibliographic data for series maintained by Wiley Content Delivery ().