Distributions implied by American currency futures options: A ghost's smile?
✍ Scribed by Martin Cincibuch
- Publisher
- John Wiley and Sons
- Year
- 2003
- Tongue
- English
- Weight
- 341 KB
- Volume
- 24
- Category
- Article
- ISSN
- 0270-7314
No coin nor oath required. For personal study only.
✦ Synopsis
Abstract
A new and easily applicable method for estimating risk‐neutral distributions (RND) implied by American futures options is
proposed. It amounts to inverting the Barone‐Adesi and Whaley method (BAW method) to get the BAW implied volatility smile. Extensive
empirical tests show that the BAW smile is equivalent to the volatility smile implied by corresponding European options. Therefore, the procedure
leads to a legitimate RND estimation method. Further, the investigation of the currency options traded on the Chicago Mercantile Exchange and OTC
markets in parallel provides us with insights on the structure and interaction of the two markets. Unequally distributed liquidity in the OTC market
seems to lead to price distortions and an ensuing interesting “ghost‐like” shape of the RND density implied by CME options.
Finally, using the empirical results, we propose a parsimonious generalization of the existing methods for estimating volatility smiles from OTC
options. A single free parameter significantly improves the fit. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:147–178, 2004