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Testing the Forecasting Performance of Ibex 35 Option-implied Risk-neutral Densities

Francisco Alonso, Roberto Blanco and Gonzalo Rubio Irigoyen

No 2005-09, DFAEII Working Papers from University of the Basque Country - Department of Foundations of Economic Analysis II

Abstract: The main objective of this paper is to test whether the risk-neutral densities (RNDs) implied in the prices of the future options contract on the Spanish IBEX 35 index accurately predict the distribution of future outcomes of the underlying asset. We estimate RNDs using both parametric and nonparametric procedures. We find that between 1996 and 2003 we cannot reject the hypothesis that the RNDs provide accurate predictions of the distributions of future realisations of the IBEX 35 index at four-week horizon. However, this result is not robust by subperiods. In particular, from October 1996 to February 2000, we find that RNDs are not able to consistently predict the actual realisations of returns. In this period, option prices assign a low risk-neutral probability to large rises compared with realisations. Tests based on the tails of the distribution show that RNDs significantly understate the right tail of the distribution for both the whole period and the first subperiod.

Keywords: risk-neutral densities; forecasting performance (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
Date: 2005-01
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Dpto. de Fundamentos del Análisis Económico II, = Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain

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