RT Journal Article
SR Electronic
T1 Universal Arbitrage-Free Estimation of State Price Density
JF The Journal of Derivatives
FD Institutional Investor Journals
SP 35
OP 59
DO 10.3905/jod.2020.1.123
VO 28
IS 3
A1 Qi Hu
A1 David Newton
YR 2021
UL https://pm-research.com/content/28/3/35.abstract
AB Given the valuable information content of Arrow–Debreu prices, the recovery of a well-behaved state price density is of considerable importance. However, this is a nontrivial task because of data limitation and the complex arbitrage-free constraints. In this article, the authors develop a more effective linear programming support vector machine estimator for state price density, which incorporates no-arbitrage restrictions and bid–ask spread. This method does not depend on a particular approximation function and framework and is, therefore, universally applicable. In a parallel empirical study, they apply the method to options on the S&P 500, showing it to be accurate and smooth.TOPICS: Derivatives, optionsKey Findings▪ Recovery of a well-behaved state price density is an important but nontrivial task because of data limitation and the complex arbitrage-free constraints.▪ The authors develop a universally applicable linear programming support vector machine estimator for state price density that incorporates no-arbitrage restrictions and bid–ask spread.▪ They apply the method empirically to options on the S&P 500, showing it to be accurate and smooth.