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Distributions implied by American currency futures options: A ghost's smile?

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  • Martin Cincibuch

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

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  • Martin Cincibuch, 2004. "Distributions implied by American currency futures options: A ghost's smile?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(2), pages 147-178, February.
    • Handle: RePEc:wly:jfutmk:v:24:y:2004:i:2:p:147-178
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    Cited by:

    1. Datta, Deepa Dhume & Londono, Juan M. & Ross, Landon J., 2017. "Generating options-implied probability densities to understand oil market events," Energy Economics, Elsevier, vol. 64(C), pages 440-457.
    2. Chen, Ren-Raw & Hsieh, Pei-lin & Huang, Jeffrey, 2018. "Crash risk and risk neutral densities," Journal of Empirical Finance, Elsevier, vol. 47(C), pages 162-189.
    3. Martin Cincibuch & David Vavra, 2004. "Testing for the uncovered interest parity using distributions implied by FX options," Money Macro and Finance (MMF) Research Group Conference 2003 16, Money Macro and Finance Research Group.

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