Long and Short-Term Dynamics of the S&P500 Option-Implied Distribution

Posted: 20 May 2013

See all articles by Yi Ling Low

Yi Ling Low

The University of Melbourne

Date Written: May 19, 2013

Abstract

We propose a modelling treatment for the option-implied risk neutral distribution (RND) which disaggregates its long-term and short-term dynamics. Long memory parameters calibrated on the RND moments serve as tractable mathematical constructs to filter out effects of smooth structural change related to investor risk aversion and macroeconomic influence; the remaining short-term effects relate to changes in investors’ objective probability distribution of future prices on the underlying asset. Time series measures of the long-term and short-term moment dynamics are separately studied in vector auto regressions. Asymmetry and tail expectations are found to be subsumed in volatility expectations and significant co-moment interactions are found in the higher-order moments. The proposed model outperforms recently proposed vector alternatives for forecasting the RND, particularly skewness and kurtosis.

Keywords: Risk Neutral Distribution, Option Pricing, Long Memory

JEL Classification: C32, G00, G12, G19

Suggested Citation

Low, Yi Ling, Long and Short-Term Dynamics of the S&P500 Option-Implied Distribution (May 19, 2013). Available at SSRN: https://ssrn.com/abstract=2267177 or http://dx.doi.org/10.2139/ssrn.2267177

Yi Ling Low (Contact Author)

The University of Melbourne ( email )

185 Pelham Street
Carlton, Victoria 3053
Australia

HOME PAGE: http://www.finance.unimelb.edu.au/who/PhDWeb.cfm?PhDNo=37

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