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A new approach to modeling the dynamics of implied distributions: Theory and evidence from the S&P 500 options
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UNSPECIFIED (2004) A new approach to modeling the dynamics of implied distributions: Theory and evidence from the S&P 500 options. JOURNAL OF BANKING & FINANCE, 28 (7). pp. 1499-1520. doi:10.1016/S0378-4266(03)00127-4 ISSN 0378-4266.
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Official URL: http://dx.doi.org/10.1016/S0378-4266(03)00127-4
Abstract
This paper presents a new approach to modeling the dynamics of implied distributions. First, we obtain a parsimonious description of the dynamics of the S&P 500 implied cumulative distribution functions by applying principal components analysis. Subsequently, we develop new arbitrage-free Monte Carlo simulation methods that model the evolution of the whole distribution through time as a diffusion process. Our approach generalizes the conventional approaches of modeling only the first two moments as diffusion processes, and it has important implications for "smile-consistent" option pricing and for risk management. The out-of-sample performance within a Value-at-Risk framework is examined. (C) 2003 Elsevier B.V. All rights reserved.
Item Type: | Journal Article | ||||
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Subjects: | H Social Sciences > HG Finance H Social Sciences > HC Economic History and Conditions |
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Journal or Publication Title: | JOURNAL OF BANKING & FINANCE | ||||
Publisher: | ELSEVIER SCIENCE BV | ||||
ISSN: | 0378-4266 | ||||
Official Date: | July 2004 | ||||
Dates: |
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Volume: | 28 | ||||
Number: | 7 | ||||
Number of Pages: | 22 | ||||
Page Range: | pp. 1499-1520 | ||||
DOI: | 10.1016/S0378-4266(03)00127-4 | ||||
Publication Status: | Published |
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