Momentum and Reversion in Risk Neutral Martingale Probabilities
27 Pages Posted: 16 Apr 2013 Last revised: 25 Mar 2014
Date Written: March 8, 2014
Abstract
A time homogeneous, purely discontinuous, parsimonous Markov martingale model is proposed for the risk neutral dynamics of equity forward prices. Transition probabilities are in the variance gamma class with spot dependent parameters. Markov chain approximations give access to option prices. The model is estimated on option prices across strike and maturity for five days at a time. Properties of the estimated processes are described via an analysis of return quantiles, momentum functions that measure the response of tail probabilities to such moves. Momentum and reversion are also addressed via the construction of reverse conditional expectations. Term structures for the moments of marginal distributions support a decay in skewenss and excess kurtosis with maturity at rates slower than those implied by Lévy processes. Out of sample performance is additionally reported. It is observed that risk neutral dynamics by and large reflect the presence of momentum in numerous probabilities. However, there is some reversion in the upper quantiles of risk neutral return distributions.
Keywords: Variance Gamma, Markov Chains, Hunt Process, Reverse Expectations
JEL Classification: G10, G12, G13
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Transform Analysis and Asset Pricing for Affine Jump-Diffusions
By Darrell Duffie, Jun Pan, ...
-
Transform Analysis and Asset Pricing for Affine Jump-Diffusions
By Darrell Duffie, Jun Pan, ...
-
The Impact of Jumps in Volatility and Returns
By Michael S. Johannes, Bjorn Eraker, ...
-
Implied Volatility Functions: Empirical Tests
By Bernard Dumas, Jeff Fleming, ...
-
Recovering Risk Aversion from Option Prices and Realized Returns
-
Recovering Probabilities and Risk Aversion from Option Prices and Realized Returns
-
Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options
By Gurdip Bakshi, Nikunj Kapadia, ...
-
Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options
By Nikunj Kapadia, Gurdip Bakshi, ...
-
Nonparametric Estimation of State-Price Densities Implicit in Financial Asset Prices
By Yacine Ait-sahalia and Andrew W. Lo