Effectiveness of Linear Extrapolation in Model-Free Implied Moment Estimation

33 Pages Posted: 6 Apr 2015 Last revised: 28 Jan 2016

Date Written: January 11, 2016

Abstract

This study proposes a new methodology with which the effectiveness of linear extrapolation (LE) of Jiang and Tian (2005) for the implied moment estimators of Bakshi et al. (2003) can be evaluated, even when the true moments are unknown. Using S&P 500 index options data and truncation sensitivity functions, this study suggests that although LE is effective for all three estimators, the implied skewness and kurtosis estimators can remain sensitive to truncation, i.e., the complete unavailability of option prices for a part of deep-out-of-the-money or deep-in-the-money region of strike price domain, even when LE is employed to mitigate truncation.

Keywords: Linear extrapolation, truncation error, model-free implied moment estimators, skewness, kurtosis

JEL Classification: C14, C58, G13

Suggested Citation

Lee, Geul, Effectiveness of Linear Extrapolation in Model-Free Implied Moment Estimation (January 11, 2016). Available at SSRN: https://ssrn.com/abstract=2590040 or http://dx.doi.org/10.2139/ssrn.2590040

Geul Lee (Contact Author)

Coinplug, Inc. ( email )

11F, Office H, 20, Pangyoyeok-ro 146beon-gil,
Bundang-gu
Seongnam-si, Gyeonggi-do
Korea, Republic of (South Korea)

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