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Revealing the Implied Risk-neutral MGF from Options: the Wavelet Method

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journal contribution
posted on 2009-06-15, 14:26 authored by Emmanuel Haven, Xiaoquan Liu, Chenghu Ma, Liya Shen
Options are believed to contain unique information on the risk-neutral moment generating function (MGF) or the risk-neutral probability density function (PDF) of the underlying asset. This paper applies the wavelet method to approximate the implied risk-neutral MGF from option prices. Monte Carlo simulations are carried out to show how the risk-neutral MGF can be obtained using the wavelet method. With the Black–Scholes model as the benchmark, we offer a novel method to reveal the implied MGF, and to price in-sample options and forecast out-of-sample option prices with the estimated MGF.

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Citation

Journal of Economic Dynamics & Control, 2009, 33 (3), pp. 692-709

Published in

Journal of Economic Dynamics & Control

Publisher

Elsevier Science B.V., Amsterdam

issn

0165-1889

Copyright date

2009

Available date

2009-06-15

Publisher version

http://www.sciencedirect.com/science/article/pii/S0165188908001632

Language

en

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