Estimating state price densities by Hermite polynomials: theory and application to the Italian derivatives market

Paolo Guasoni ()
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Paolo Guasoni: Universita' di Pisa

No 507, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We study the problem of extracting the state price densities from the market prices of listed options. Adapting a model of Madan and Milne to a multiple expiration setting, we present an estimation method for the risk-neutral probability at a moving horizon of fixed length. With the exception of volatility, all model parameters can be estimated by linear regression and their number can be chosen arbitrarily, depending on the size of the dataset. We discuss empirical issues related to the application of this model to real data and show results on listed options on the Italian MIB30 equity index.

Keywords: option pricing; state-price densities; orthogonal polynomials; risk-neutral valuation; calibration (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2004-07
New Economics Papers: this item is included in nep-fin and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:bdi:wptemi:td_507_04

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