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The information content of risk-neutral densities: tests based on Hungarian currency option-implied densities

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  • Csaba Csavas

Abstract

In this paper we test the information content of risk-neutral density functions estimated by the method of Malz [1997. Estimating the probability distribution of the future exchange rate from options prices. Journal of Derivatives 5, no. 2: 18-36]. The main question is whether risk-neutral densities coincide with the subjective densities. We find that the forecasting ability of 1-month EUR/HUF risk-neutral densities can be rejected for the period 2003-2007. Higher moments are responsible for the poor forecasting ability. Our interpretation is that the standard deviation, the skewness and the kurtosis of the risk-neutral densities are significantly above the respective central moments of subjective densities. We also find that delta-hedged gains on purchased options are negative, and can be considered high compared with the transaction costs of delta hedging.

Suggested Citation

  • Csaba Csavas, 2010. "The information content of risk-neutral densities: tests based on Hungarian currency option-implied densities," The European Journal of Finance, Taylor & Francis Journals, vol. 16(7), pages 657-676.
    • Handle: RePEc:taf:eurjfi:v:16:y:2010:i:7:p:657-676
    DOI: 10.1080/1351847X.2010.481451
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    Cited by:

    1. Roh, Tai-Yong & Byun, Suk Joon & Xu, Yahua, 2020. "Downside uncertainty shocks in the oil and gold markets," International Review of Economics & Finance, Elsevier, vol. 66(C), pages 291-307.
    2. Sensoy, Ahmet & Serdengeçti, Süleyman, 2020. "Impact of portfolio flows and heterogeneous expectations on FX jumps: Evidence from an emerging market," International Review of Financial Analysis, Elsevier, vol. 68(C).

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