Implicit Probability Distribution for WTI Options: The Black Scholes vs. The Semi-Nonparametric Approach

26 Pages Posted: 25 Jan 2018

See all articles by Lina Cortes

Lina Cortes

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF)

Andrés Mora-Valencia

Universidad de los Andes, Colombia - School of Management

Javier Perote

University of Salamanca

Multiple version iconThere are 2 versions of this paper

Date Written: December 5, 2017

Abstract

This paper contributes to the literature on the estimation of the Risk Neutral Density (RND) function by modeling the prices of options for West Texas Intermediate (WTI) crude oil that were traded in the period between January 2016 and January 2017. For these series we extract the implicit RND in the option prices by applying the traditional Black & Scholes (1973) model and the semi-nonparametric (SNP) model proposed by Backus, Foresi, Li, & Wu (1997). The results obtained show that when the average market price is compared to the average theoretical price, the lognormal specification tends to systematically undervalue the estimation. On the contrary, the SNP option pricing model, which explicitly adjust for negative skewness and excess kurtosis, results in markedly improved accuracy.

Keywords: Oil prices, option pricing, risk neutral density, semi-nonparametric approach

JEL Classification: Q47, G12, C14

Suggested Citation

Cortes, Lina and Mora-Valencia, Andrés and Perote, Javier, Implicit Probability Distribution for WTI Options: The Black Scholes vs. The Semi-Nonparametric Approach (December 5, 2017). Center for Research in Economics and Finance (CIEF), Working Papers, No. 17-23, Available at SSRN: https://ssrn.com/abstract=3107361 or http://dx.doi.org/10.2139/ssrn.3107361

Lina Cortes (Contact Author)

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF) ( email )

Carrera 49 No. 7 South - 50
Bogotá
Colombia

Andrés Mora-Valencia

Universidad de los Andes, Colombia - School of Management ( email )

Carrera Primera # 18A-12
Bogotá
Colombia

Javier Perote

University of Salamanca ( email )

Campus Miguel de Unamuno
ES-37007 Salamanca, Salamanca 23007
Spain

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