Journal of Banking & Finance Vol. 31 No. 5 2007
Closed-form transformations from risk-neutral to real-world distributions
Abstract
Risk-neutral and real-world densities are derived from option prices and risk assumptions, and are compared with historical densities obtained from time series. Two parametric risk-transformations are used to convert risk-neutral densities into real-world densities. Both transformations are estimated by maximizing the likelihood of observed index levels, for two parametric density families. Results for the FTSE-100 index show that parametric densities derived from option prices have more explanatory power than historical densities and higher likelihoods than densities estimated by spline methods. A combination of parametric real-world and historical densities provides the preferred predictive densities.
- DOI
- 10.1016/j.jbankfin.2006.09.005
- Volume
- 31
- Issue
- 5
- Pages
- 1501-1520
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref