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Reading the Smile: The Message Conveyed by Methods which Infer Risk Neutral Densities

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Abstract

In this study, we compare the quality and information content of risk neutral densities obtained by various methods. We consider a non-parametric method based on a mixture of log-normal densities, the semi-parametric ones based on an Hermite approximation or based on an Edgeworth expansion, the parametric approach of Malz which assumes a jump-diffusion for the underlying process, and Heston's approach assuming a stochastic volatility model. We apply those models on FF/DM exchange rate options for two dates. Models differ when important news hits the market (here anticipated elections). The non-parametric model provides a good fit to options prices but is unable to provide as much information about market participants expectations than the jump-diffusion model.
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hal-00601591 , version 1 (19-06-2011)

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  • HAL Id : hal-00601591 , version 1

Cite

Michael Rockinger, Eric Jondeau. Reading the Smile: The Message Conveyed by Methods which Infer Risk Neutral Densities. 1997. ⟨hal-00601591⟩

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