Option Market Prediction of the S&P 500 Index Return Distribution
(English)Manuscript (preprint) (Other academic)
In this paper we evaluate the density forecasts obtained from a cross-section of S&P 500 index option prices. The option implied density forecasts rely on a result derived by Heath and Platen (2006), which under certain assumptions allows us to transform risk-neutral densities into real-world densities. In order to remove liquidity premia from the real-world densities we use a transformation into densities implied by the Minimal Market Model. The accuracy of the estimated real-world density forecasts relies on using a recently developed method for estimation of risk-neutral densities of high quality. We find that our recovered real-world densities explains the realized return distribution for S&P 500 better than historical GARCH densities for a forecasting horizon of two days. This can be contrasted to the findings in two recent papers in the literature, who find that historical densities estimated from intra-day data performs as least as well as option implied densities for a forecasting horizon of one day.
Option implied information; Density forecast evaluation; Real-world density; Local volatility model; Non-parametric estimation
Economics and Business
IdentifiersURN: urn:nbn:se:liu:diva-117105OAI: oai:DiVA.org:liu-117105DiVA: diva2:805727