Nonparametric Option Pricing with Generalized Entropic Estimators
49 Pages Posted: 10 Dec 2014
Date Written: August 28, 2014
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
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