Year: 2021
Type: article
Abstract: We present a model for direct semi-parametric estimation of the state price density (SPD) implied by quoted option prices. We treat the observed prices as expected values of possible pay-offs at maturity, weighted by the unknown probability density function. We model the logarithm of the latter as a smooth function, using P-splines, while matching the expected values of the potential pay-offs with the observed prices. This leads to a special case of the penalized composite link model. Our estimates do not rely on any parametric assumption on the underlying asset price dynamics and are consistent with no-arbitrage conditions. The model shows excellent performance in simulations and in applications to real data.
Authors: Gianluca Frasso, Paul H.C. Eilers
Institutions: University of Liège, Erasmus MC
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W2542345571