Author : Omid M. Ardakani
Publisher :
Page : 0 pages
File Size : 40,19 MB
Release : 2022
Category :
ISBN :
Entropy pricing applies notions of information theory to derive the theoretical value of options. This paper employs the maximum entropy formulation of option pricing, given risk-neutral moment constraints computed directly from the observed prices. First, higher-order moments are used to generate option prices. Then a generalization of Shannon entropy, known as Renyi entropy, is studied to account for extreme events. This maximum entropy problem provides a class of heavy-tailed distributions. Examples and Monte Carlo simulations are provided to examine the effects of moment constraints on option prices. The call option values are then constructed using daily S&P 500 index options. The findings suggest that entropy pricing with higher-order moment constraints provides higher forecasting accuracy.