Risk-Neutral Moment-Based Estimation of Affine Option Pricing Models
57 Pages Posted: 16 Aug 2015 Last revised: 31 Mar 2018
Date Written: November 2, 2017
This paper provides a novel methodology for estimating option pricing models based on risk-neutral moments. We synthesize the distribution extracted from a panel of option prices and exploit linear relationships between risk-neutral cumulants and latent factors within the continuous time affine stochastic volatility framework. We find that fitting the Andersen, Fusari, and Todorov (2015b) option valuation model to risk-neutral moments captures the bulk of the information in option prices. Our estimation strategy is effective, easy to implement, and robust, as it allows for a direct linear filtering of the latent factors and a quasi-maximum likelihood estimation of model parameters. From a practical perspective, employing risk-neutral moments instead of option prices also helps circumvent several sources of numerical errors and substantially lessens the computational burden inherent in working with a large panel of option contracts.
Keywords: Risk-neutral moments, Affine models, Stochastic volatility, Latent factors
JEL Classification: G12
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