Nonparametric estimation of state-price densities implicit in financial asset prices

Yacine Aït-Sahalia, Andrew W. Lo

Research output: Contribution to journalArticle

439 Scopus citations

Abstract

Implicit in the prices of traded financial assets are Arrow-Debreu prices or, with continuous states, the state-price density (SPD). We construct a nonparametric estimator for the SPD implicit in option prices and we derive its asymptotic sampling theory. This estimator provides an arbitrage-free method of pricing new, complex, or illiquid securities while capturing those features of the data that are most relevant from an asset-pricing perspective, for example, negative skewness and excess kurtosis for asset returns, and volatility "smiles" for option prices. We perform Monte Carlo experiments and extract the SPD from actual S&P 500 option prices.

Original languageEnglish (US)
Pages (from-to)499-547
Number of pages49
JournalJournal of Finance
Volume53
Issue number2
DOIs
StatePublished - Apr 1998

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

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