Comparison of volatility function technique for risk-neutral densities estimation

Volatility function technique by using interpolation approach plays an important role in extracting the risk-neutral density (RND) of options. The aim of this study is to compare the performances of two interpolation approaches namely smoothing spline and fourth order polynomial in extracting the RN...

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Main Authors: Bahaludin, Hafizah, Abdullah, Mimi Hafizah
Format: Conference or Workshop Item
Language:English
English
Published: American Institute of Physics 2017
Subjects:
Online Access:http://irep.iium.edu.my/57987/8/57987-Comparison%20of%20Volatility.pdf
http://irep.iium.edu.my/57987/14/Comparison%20of%20volatility%20function%20technique%20for%20risk-neutral%20densities%20estimation.pdf
http://irep.iium.edu.my/57987/
http://aip.scitation.org/doi/10.1063/1.4995905
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Institution: Universiti Islam Antarabangsa Malaysia
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spelling my.iium.irep.579872019-10-09T00:45:22Z http://irep.iium.edu.my/57987/ Comparison of volatility function technique for risk-neutral densities estimation Bahaludin, Hafizah Abdullah, Mimi Hafizah QA Mathematics Volatility function technique by using interpolation approach plays an important role in extracting the risk-neutral density (RND) of options. The aim of this study is to compare the performances of two interpolation approaches namely smoothing spline and fourth order polynomial in extracting the RND. The implied volatility of options with respect to strike prices/delta are interpolated to obtain a well behaved density. The statistical analysis and forecast accuracy are tested using moments of distribution. The difference between the first moment of distribution and the price of underlying asset at maturity is used as an input to analyze forecast accuracy. RNDs are extracted from the Dow Jones Industrial Average (DJIA) index options with a one month constant maturity for the period from January 2011 until December 2015. The empirical results suggest that the estimation of RND using a fourth order polynomial is more appropriate to be used compared to a smoothing spline in which the fourth order polynomial gives the lowest mean square error (MSE). The results can be used to help market participants capture market expectations of the future developments of the underlying asset. American Institute of Physics 2017 Conference or Workshop Item PeerReviewed application/pdf en http://irep.iium.edu.my/57987/8/57987-Comparison%20of%20Volatility.pdf application/pdf en http://irep.iium.edu.my/57987/14/Comparison%20of%20volatility%20function%20technique%20for%20risk-neutral%20densities%20estimation.pdf Bahaludin, Hafizah and Abdullah, Mimi Hafizah (2017) Comparison of volatility function technique for risk-neutral densities estimation. In: The 24th National Symposium On Mathematical Sciences: Mathematical Sciences Exploration For The Universal Preservation, 27-29 Sept 2016, Kuala Terengganu, Terengganu, Malaysia.. http://aip.scitation.org/doi/10.1063/1.4995905 10.1063/1.4995905
institution Universiti Islam Antarabangsa Malaysia
building IIUM Library
collection Institutional Repository
continent Asia
country Malaysia
content_provider International Islamic University Malaysia
content_source IIUM Repository (IREP)
url_provider http://irep.iium.edu.my/
language English
English
topic QA Mathematics
spellingShingle QA Mathematics
Bahaludin, Hafizah
Abdullah, Mimi Hafizah
Comparison of volatility function technique for risk-neutral densities estimation
description Volatility function technique by using interpolation approach plays an important role in extracting the risk-neutral density (RND) of options. The aim of this study is to compare the performances of two interpolation approaches namely smoothing spline and fourth order polynomial in extracting the RND. The implied volatility of options with respect to strike prices/delta are interpolated to obtain a well behaved density. The statistical analysis and forecast accuracy are tested using moments of distribution. The difference between the first moment of distribution and the price of underlying asset at maturity is used as an input to analyze forecast accuracy. RNDs are extracted from the Dow Jones Industrial Average (DJIA) index options with a one month constant maturity for the period from January 2011 until December 2015. The empirical results suggest that the estimation of RND using a fourth order polynomial is more appropriate to be used compared to a smoothing spline in which the fourth order polynomial gives the lowest mean square error (MSE). The results can be used to help market participants capture market expectations of the future developments of the underlying asset.
format Conference or Workshop Item
author Bahaludin, Hafizah
Abdullah, Mimi Hafizah
author_facet Bahaludin, Hafizah
Abdullah, Mimi Hafizah
author_sort Bahaludin, Hafizah
title Comparison of volatility function technique for risk-neutral densities estimation
title_short Comparison of volatility function technique for risk-neutral densities estimation
title_full Comparison of volatility function technique for risk-neutral densities estimation
title_fullStr Comparison of volatility function technique for risk-neutral densities estimation
title_full_unstemmed Comparison of volatility function technique for risk-neutral densities estimation
title_sort comparison of volatility function technique for risk-neutral densities estimation
publisher American Institute of Physics
publishDate 2017
url http://irep.iium.edu.my/57987/8/57987-Comparison%20of%20Volatility.pdf
http://irep.iium.edu.my/57987/14/Comparison%20of%20volatility%20function%20technique%20for%20risk-neutral%20densities%20estimation.pdf
http://irep.iium.edu.my/57987/
http://aip.scitation.org/doi/10.1063/1.4995905
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