Search Results
Showing results 1 to 2 of approximately 2.
(refine search)
Working Paper
Recovering risk aversion from options
Cross-sections of option prices embed the risk-neutral probability densities functions (PDFs) for the future values of the underlying asset. Theory suggests that risk-neutral PDFs differ from market expectations due to risk premia. Using a utility function to adjust the risk-neutral PDF to produce subjective PDFs, we can obtain measures of the risk aversion implied in option prices. Using FTSE 100 and S&P 500 options, and both power and exponential utility functions, we show that subjective PDFs accurately forecast the distribution of realizations, while risk-neutral PDFs do not. The ...
Working Paper
Testing the stability of implied probability density functions
Implied probability density functions (PDFs) estimated from cross-sections of observed options prices are gaining increasing attention amongst academics and practitioners. However, to date little attention has been paid to the robustness of these estimates or to the confidence users can place in the summary statistics, for example skewness or the 99th percentile, derived from fitted PDFs. This paper begins to address these questions by examining the absolute and relative robustness of two of the most common methods for estimating implied smile methods. The changes resulting from randomly ...