[PDF] Option Implied Risk Neutral Distributions And Implied Binomial Trees eBook

Author : Jens Carsten Jackwerth
Publisher :
Page : 17 pages
File Size : 24,98 MB
Release : 2008
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In this partial and selective literature review of option implied risk-neutral distributions and of implied binomial trees, we start by observing that in efficient markets, there is information contained in option prices, which might help us to design option pricing models. To this end, we review the numerous methods of recovering risk-neutral probability distributions from option prices at one particular time-to-expiration and their applications. Next, we extend our attention beyond one time-to-expiration to the construction of implied binomial trees, which model the stochastic process of the underlying asset. Finally, we describe extensions of implied binomial trees, which incorporate stochastic volatility, as well as other non-parametric methods.

Author : Tom Arnold
Publisher :
Page : 46 pages
File Size : 34,45 MB
Release : 2009
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Arnold, Crack and Schwartz (2010) generalize the Rubinstein (1994) risk-neutral implied binomial tree (R-IBT) model by introducing a risk premium. Their new risk-averse implied binomial tree model (RA-IBT) has both probabilistic and pricing applications. They use the RA-IBT model to estimate the pricing kernel (i.e., marginal rate of substitution) and implied relative risk aversion for a representative agent. This paper presents additional theoretical details on the use of assumed utility functions to generate discount rates in the RA-IBT and theoretical details on the propagation of risk-averse probabilities through an RA-IBT (and how this process differs from the propagation of probabilities through a Rubinstein R-IBT). We also present both no-arbitrage and CAPM-driven derivations of the certainty equivalent risk-adjusted discounting formula that is used in Arnold, Crack and Schwartz (2010) and a direct estimation routine for the RA-IBT that is similar to Rubinstein's ldquo;one-two-threerdquo; technique. This paper also presents additional empirical applications of the model, including a comparison of risk-neutral and risk-averse implied distributions, and applications of the RA-IBT to financial options trading, time series return forecasting, and a previously infeasible corporate finance real option valuation problem. We also use the RA-IBT to explore the differences between risk-neutral and risk-averse moments of returns. We also discuss practical applications of the RA-IBT model to Value at Risk and stochastic volatility option pricing models.

Author : Tom Arnold
Publisher :
Page : 38 pages
File Size : 17,19 MB
Release : 2006
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A real option on a commodity is valued using an implied binomial tree (IBT) calibrated using commodity futures options prices. Estimating an IBT in the absence of spot options (the norm for commodities) allows real option models to be calibrated for the first time to market-implied probability distributions for commodity prices. Also, the existence of long-dated futures options means that good volatility estimates may now be incorporated into capital budgeting evaluations of real options projects with long planning horizons. An example is given using gold futures options and a real option to extract gold from a mine. We include a unique out-of-sample test that shows how option pricing errors evolve on sub-trees emanating from future levels of the underlying.

Author : Jessica List
Publisher :
Page : pages
File Size : 43,76 MB
Release : 2008
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This thesis empirically analyses implied risk neutral probability distributions of SMI index options. The contribution of this thesis is its data base (SMI index options), the long observation period (1999 - 2008) and its attempt to use the framework of option implied risk neutral probability distributions in the context of trading strategies. The influence of important market variables (such as the risk premium and the term structure of Swiss interest rates) on the estimated RNDs summary statistics is analysed in a regression framework accounting for heteroscedasticity and autocorrelation of the variables under consideration. It turns out that most of the analysed domestic market variables do not have a significant influence on the calculated implied RND's summary statistics and no significant international spillovers are observable. In addition, option implied moments, in particular the volatility of the implied RND, seem to be poor predictors for future moments of the SMI return distribution. Trading strategies based on option implied information are implemented. After accounting for transaction costs, some of these strategies are not only able to outperform a direct investment in the underlying, but systematically outperformed comparable trading strategies based on spot prices.

Author : Tom Arnold
Publisher :
Page : 21 pages
File Size : 42,26 MB
Release : 2004
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We show how to implement a Rubinstein (1994) implied binomial tree using an Excel spreadsheet, but without having to use visual basic in Excel (VBA). We demonstrate both the optimization needed to generate implied ending risk-neutral probabilities from a set of actual option prices and the backwards recursion needed to solve for the entire implied tree. By using only standard Excel functions, and not resorting to VBA, we make this option pricing technique immediately accessible to both practitioners and academics. With minimal preparation, this technique can also be introduced to the undergraduate classroom.