Non-structural approach to implied moments extraction

• Published in: Economic research - Ekonomska istraživanja Vol. 31; no. 1; pp. 1923 - 1939
• Main Authors: Šestanović, Tea, Arnerić, Josip, Aljinović, Zdravka
• Format: Journal Article Paper
• Language: English
• Published: Pula Routledge 01.01.2018; Taylor & Francis Ltd; Taylor and Francis Group i Sveučilište Jurja Dobrile u Puli, Fakultet ekonomije i turizma Dr. Mijo Mirković
• Subjects: Economic theory; Edgeworth expansions; Extraction; implied moments; mixture of two log-normals; Prices; Probability distribution; Securities prices; Shimko's model; Shimko’s mode; Stock market indexes; Structural models; Volatility
• ISSN: 1331-677X; 1848-9664
• DOI: 10.1080/1331677X.2018.1530607

Moments of future prices and returns are not observable, but it is possible to measure them indirectly. A set of option prices with the same maturity but with different exercise prices are used to extract implied probability distribution of the underlying asset at the expiration date. The aim is to obtain market expectations from options and to investigate which non-structural model for estimating implied probability distribution gives the best fit. Non-structural models assume that only dynamics in prices is known. Mixture of two log-normals (MLN), Edgeworth expansions and Shimko's model (representatives of parametric, semiparametric and nonparametric approaches respectively) are compared. Previous researches are inconclusive about the superiority of one approach over the others. This article contributes to finding which approach dominates. The best fit model is used to describe moments of the implied probability distribution. The sample covers one-year data for DAX index options. The results are compared through models and maturities. All models give better short-term forecasts. In pairwise comparison, MLN is superior to other approaches according to mean squared errors and Diebold-Mariano test in the observed period for DAX index options.