Nonparametric Option Pricing with Generalized Entropic Estimators

49 Pages Posted: 10 Dec 2014

See all articles by Caio Almeida

Caio Almeida

Getulio Vargas Foundation ; Princeton University

Rafael Azevedo

Getulio Vargas Foundation (FGV)

Date Written: August 28, 2014

Abstract

Pricing options in incomplete markets is a challenging task due to the existence of infinite risk-neutral measures that correctly price the underlying asset but give alternative prices for the option payoff. In this context, we analyze a large family of entropic discrepancy loss functions each implying a risk-neutral measure that takes into account specific combinations of higher moments of the underlying return process. We test the ability of these risk-neutral measures to reproduce theoretical option prices for different moneynesses and maturities when the simulated DGP for the underlying asset is given by a realistic jump-diffusion process. A specific subset of measures is identified as the best to price options under the adopted jump-diffusion model. We make use of this subset to suggest robust price intervals for options as opposed to single prices.

Keywords: Risk-Neutral Measure, Option Pricing, Nonparametric Estimation, Robustness, Minimum Contrast Estimators, Cressie Read Discrepancies

JEL Classification: C1,C5,C6,G1

Suggested Citation

Almeida, Caio and Azevedo, Rafael, Nonparametric Option Pricing with Generalized Entropic Estimators (August 28, 2014). Available at SSRN: https://ssrn.com/abstract=2535790 or http://dx.doi.org/10.2139/ssrn.2535790

Caio Almeida (Contact Author)

Getulio Vargas Foundation ( email )

Praia de Botafogo 190, 11o andar
Botafogo
Rio de Janeiro, Rio de Janeiro 22250-900
Brazil
5521-37995827 (Phone)
5521-2553-8821 (Fax)

HOME PAGE: http://www.fgv.br/professor/calmeida/

Princeton University ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

Rafael Azevedo

Getulio Vargas Foundation (FGV) ( email )

R. Dr. Neto de Araujo 320 cj 1307
Rio de Janeiro, Rio de Janeiro 22250-900
Brazil

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