Recovering the Real-World Density and Liquidity Premia from Option Data
2016 (English)In: Quantitative finance (Print), ISSN 1469-7688, E-ISSN 1469-7696, Vol. 16, no 7, 1147-1164 p.Article in journal (Refereed) Published
In this paper we develop a methodology for simultaneous recovery of the real-world probability density and liquidity premia from observed S&P500 index option prices. Assuming the existence of a numeraire portfolio for the US equity market, fair prices of derivatives under the benchmark approach can be obtained directly under the real-world measure. Under this modeling framework there exists a direct link between observed call option prices on the index and the real-world density for the underlying index. We use a novel method for estimation of option implied volatility surfaces of high quality which enables the subsequent analysis. We show that the real-world density that we recover is consistent with the observed realized dynamics of the underlying index. This admits the identication of liquidity premia embedded in option price data. We identify and estimate two separate liquidity premia embedded in S&P500 index options that are consistent with previous findings in the literature.
Place, publisher, year, edition, pages
Taylor & Francis, 2016. Vol. 16, no 7, 1147-1164 p.
Real-world density; Liquidity premia; Local volatility model; No-nparametric estimation; Simulated Maximum Likelihood
Economics and Business
IdentifiersURN: urn:nbn:se:liu:diva-117104DOI: 10.1080/14697688.2015.1128117ISI: 000379836500011OAI: oai:DiVA.org:liu-117104DiVA: diva2:805724