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Risk-Neutral Moment-Based Estimation of Affine Option Pricing Models

57 Pages Posted: 16 Aug 2015 Last revised: 4 Nov 2017

Bruno Feunou

Bank of Canada

Cedric Okou

University of Quebec at Montreal (UQAM)

Date Written: November 2, 2017

Abstract

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

Suggested Citation

Feunou, Bruno and Okou, Cedric, Risk-Neutral Moment-Based Estimation of Affine Option Pricing Models (November 2, 2017). Available at SSRN: https://ssrn.com/abstract=2644635 or http://dx.doi.org/10.2139/ssrn.2644635

Bruno Feunou

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada
613-782-8302 (Phone)

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Cedric Okou (Contact Author)

University of Quebec at Montreal (UQAM) ( email )

PB 8888 Station DownTown
Succursale Centre Ville
Montreal, Quebec H3C3P8
Canada
514-987-3000 Ext. 5521 (Phone)

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