Estimating the Implied Risk‐Neutral Density for the US Market Portfolio*

Stephen Figlewski

in Volatility and Time Series Econometrics

Published in print March 2010 | ISBN: 9780199549498
Published online May 2010 | e-ISBN: 9780191720567 | DOI:

Series: Advanced Texts in Econometrics

 Estimating the Implied Risk‐Neutral Density for the US Market Portfolio*

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This chapter presents a new methodology for extracting complete well-behaved risk-neutral density (RND) functions from options market prices, and illustrates the potential of this tool for understanding how expectations and risk preferences are incorporated into prices in the US stock market. It reviews a variety of techniques for obtaining smooth densities from a set of observed options prices and selects one that offers good performance. This procedure is then modified to incorporate the market's bid-ask spread into the estimation. The chapter shows how the tails of the RND obtained from the options market may be extended and completed by appending tails from a generalized extreme value (GEV) distribution. The procedure is employed in order to estimate RNDs for the S&P 500 stock index from 1996-2008, and develops several interesting results.

Keywords: risk-neutral density functions; options market prices; US stock market; S&P 500 stock index

Chapter.  14159 words.  Illustrated.

Subjects: Econometrics and Mathematical Economics

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