Nonparametric Estimation of State-Price Densities Implicit in Financial Asset Prices

Yacine Aït-Sahalia, Andrew W. Lo
1998 Journal of Finance  
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
more » ... osis 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.
doi:10.1111/0022-1082.215228 fatcat:zamkndk5mfhvlg5or3wqlmyppq