Working Paper Series no. 47: Estimation et interprétation des densités neutres au risque : une comparaison de méthodes

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 of Madan and Milne, or based on an Edgeworth expansion of Jarrow and Rudd, the parametric approach of Malz which assumes a jump-diffusion for the underlying process, and eventually Heston's approach assuming a stochastic volatility model. We apply those models on FRF/DEM exchange rate options for two dates, for various maturities. Models differ when important news hit the market (here the 1997 snap elections). The non-parametric model provides a good fit to options prices but is unable under critical circumstances to provide as much information about market participants expectations than Malz's jump-diffusion model.

Eric Jondeau and Michael Rockinger
October 1997

Classification JEL : C52 , G14, F31, F33.

Keywords : Risk neutral density, Option pricing, Exchange rate option