It Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling

It is generally said that out-of-the-money call options are expensive and one can ask the question from which moneyness level this is the case. Expensive actually means that the price one pays for the option is more than the discounted average payoff one receives. If so, the option bears a negative...

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Autores principales:	Stephan Höcht, Dilip B. Madan, Wim Schoutens, Eva Verschueren
Formato:	article
Lenguaje:	EN
Publicado:	MDPI AG 2021
Materias:	pricing density physical density bilateral gamma tilted bilateral gamma call option risk premium Insurance HG8011-9999
Acceso en línea:	https://doaj.org/article/1436275c1e4f486ca901171047b48538
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spelling	oai:doaj.org-article:1436275c1e4f486ca901171047b485382021-11-25T18:56:08ZIt Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling10.3390/risks91101962227-9091https://doaj.org/article/1436275c1e4f486ca901171047b485382021-11-01T00:00:00Zhttps://www.mdpi.com/2227-9091/9/11/196https://doaj.org/toc/2227-9091It is generally said that out-of-the-money call options are expensive and one can ask the question from which moneyness level this is the case. Expensive actually means that the price one pays for the option is more than the discounted average payoff one receives. If so, the option bears a negative risk premium. The objective of this paper is to investigate the zero-risk premium moneyness level of a European call option, i.e., the strike where expectations on the option’s payoff in both the <inline-formula><math xmlns="http://www.w3.org/1998/Math/MathML" display="inline"><semantics><mi mathvariant="script">P</mi></semantics></math></inline-formula>- and <inline-formula><math xmlns="http://www.w3.org/1998/Math/MathML" display="inline"><semantics><mi mathvariant="script">Q</mi></semantics></math></inline-formula>-world are equal. To fully exploit the insights of the option market we deploy the Tilted Bilateral Gamma pricing model to jointly estimate the physical and pricing measure from option prices. We illustrate the proposed pricing strategy on the option surface of stock indices, assessing the stability and position of the zero-risk premium strike of a European call option. With small fluctuations around a slightly in-the-money level, on average, the zero-risk premium strike appears to follow a rather stable pattern over time.Stephan HöchtDilip B. MadanWim SchoutensEva VerschuerenMDPI AGarticlepricing densityphysical densitybilateral gammatilted bilateral gammacall optionrisk premiumInsuranceHG8011-9999ENRisks, Vol 9, Iss 196, p 196 (2021)
institution	DOAJ
collection	DOAJ
language	EN
topic	pricing density physical density bilateral gamma tilted bilateral gamma call option risk premium Insurance HG8011-9999
spellingShingle	pricing density physical density bilateral gamma tilted bilateral gamma call option risk premium Insurance HG8011-9999 Stephan Höcht Dilip B. Madan Wim Schoutens Eva Verschueren It Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling
description	It is generally said that out-of-the-money call options are expensive and one can ask the question from which moneyness level this is the case. Expensive actually means that the price one pays for the option is more than the discounted average payoff one receives. If so, the option bears a negative risk premium. The objective of this paper is to investigate the zero-risk premium moneyness level of a European call option, i.e., the strike where expectations on the option’s payoff in both the <inline-formula><math xmlns="http://www.w3.org/1998/Math/MathML" display="inline"><semantics><mi mathvariant="script">P</mi></semantics></math></inline-formula>- and <inline-formula><math xmlns="http://www.w3.org/1998/Math/MathML" display="inline"><semantics><mi mathvariant="script">Q</mi></semantics></math></inline-formula>-world are equal. To fully exploit the insights of the option market we deploy the Tilted Bilateral Gamma pricing model to jointly estimate the physical and pricing measure from option prices. We illustrate the proposed pricing strategy on the option surface of stock indices, assessing the stability and position of the zero-risk premium strike of a European call option. With small fluctuations around a slightly in-the-money level, on average, the zero-risk premium strike appears to follow a rather stable pattern over time.
format	article
author	Stephan Höcht Dilip B. Madan Wim Schoutens Eva Verschueren
author_facet	Stephan Höcht Dilip B. Madan Wim Schoutens Eva Verschueren
author_sort	Stephan Höcht
title	It Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling
title_short	It Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling
title_full	It Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling
title_fullStr	It Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling
title_full_unstemmed	It Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling
title_sort	it takes two to tango: estimation of the zero-risk premium strike of a call option via joint physical and pricing density modeling
publisher	MDPI AG
publishDate	2021
url	https://doaj.org/article/1436275c1e4f486ca901171047b48538
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It Takes Two to Tango: Estimation of the Zero-Risk Premium Strike of a Call Option via Joint Physical and Pricing Density Modeling

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