Estimating Risk-Neutral Density with Parametric Models in Interest Rate Markets

Tunaru, R. and Fabozzi, F. and Albota, G. (2009) Estimating Risk-Neutral Density with Parametric Models in Interest Rate Markets. Quantitative Finance, 9 (1). pp. 55-70. ISSN 1469-7688 . (The full text of this publication is not available from this repository)

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Official URL
http://dx.doi.org/10.1080/14697680802272045

Abstract

The departure in modelling terms from the log-normal distribution for option pricing has been largely driven by empirical observations on skewness. In recent years, the Weibull and generalized beta distributions have been used to fit the risk-neutral density from option prices. In this article, we also propose the use of the generalized gamma distribution for recovering the risk-neutral density. In terms of complexity, this distribution, having three parameters, falls between the Weibull and generalized beta distributions. New option pricing formulas for European call and put options are derived under the generalized gamma distribution. The empirical evidence based on a set of interest rate derivatives data indicates that this distribution is capable of producing the same type of performance as the Weibull, generalized beta, and Burr3 distributions. In addition, we analyze the effect of July 2005 bombings in London on interest rate markets under the best fitting distribution. Our results indicate that there was very little impact on the volatility of these markets.

Item Type: Article
Uncontrolled keywords: Risk-neutral density; Real-world density; Power utility Function, Generalized beta distribution, Generalized gamma distribution, Burr3 distribution, Caps and floors
Subjects: H Social Sciences > H Social Sciences (General)
Divisions: Faculties > Social Sciences > Kent Business School > Accounting and Finance
Depositing User: Jennifer Knapp
Date Deposited: 19 Jul 2010 10:09
Last Modified: 23 Apr 2012 13:21
Resource URI: http://kar.kent.ac.uk/id/eprint/25099 (The current URI for this page, for reference purposes)
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