A Closed-Form Approach to Valuing Risk-Neutral Moments from Option Prices

36 Pages Posted: 12 Feb 2016 Last revised: 12 Jul 2018

See all articles by Aristogenis Lazos

Aristogenis Lazos

University of Essex

Jerry Coakley

University of Essex - Essex Business School

Xiaoquan Liu

Nottingham University Business School

Date Written: April 1, 2018

Abstract

This paper develops closed-form solutions for the finite integrals in the volatility, cubic and quartic contracts in Bakshi, Kapadia and Madan (2003) which avoid discretization errors and do not involve interpolation and extrapolation. It compares the accuracy of the closed-form approach with the popular interpolation-extrapolation approach in the literature. Our results show that the closed-form approach provides more accurate estimates for skewness. This holds across different option pricing models and parameterization which have been shown to be favourable for the interpolation-extrapolation approach. Finally, our results show that the closed-form approach always extracts expectations consistent with the term structure of the volatility smirk whereas the interpolation-extrapolation approach fails several times.

Keywords: Model-free Moment; Option Valuation; Jump Diffusion Model; Stochastic Volatility model.

JEL Classification: G12, G13

Suggested Citation

Lazos, Aristogenis and Coakley, Jerry and Liu, Xiaoquan, A Closed-Form Approach to Valuing Risk-Neutral Moments from Option Prices (April 1, 2018). Available at SSRN: https://ssrn.com/abstract=2731103 or http://dx.doi.org/10.2139/ssrn.2731103

Aristogenis Lazos (Contact Author)

University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Jerry Coakley

University of Essex - Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom
+44 1206 872455 (Phone)
+44 1206 873429 (Fax)

HOME PAGE: http://www.essex.ac.uk/afm/staff/coakley.shtm

Xiaoquan Liu

Nottingham University Business School ( email )

199 Taikang East Road
Yingzhou
Ningbo, Zhejiang 315100
China

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