Index Option Returns and Generalized Entropy Bounds
80 Pages Posted: 21 Sep 2012 Last revised: 5 Sep 2019
Date Written: September 4, 2019
We develop a new continuum of nonparametric bounds. They stem from the solution of an optimization problem that is complementary to Hansen and Jagannathan's (1991) approach, and are shown to complete the nonparametric bound universe the literature has so far discovered. Through the lens of these bounds, we estimate rare-event distributions using index option returns. We show that standard disaster models and their perturbations are unable to meet the bounds implied by simple static option trading strategies. We also highlight the potential and the necessity of having more sophisticated disaster models to reconcile model moments with the index option data.
Keywords: High-order moments, Pricing kernel, Rare disasters, Index options, Nonparametric bounds, Model diagnosis
JEL Classification: C10, C14, E21, G11, G12
Suggested Citation: Suggested Citation