We examine the intraday behavior of the risk neutral probability density (RND) for the Standard and Poor's 500 Index extracted from a continuous real-time data feed of bid and ask quotes for index options. This allows an exceptionally detailed view of how investors' expectations about returns...

In the reduced-form approach to credit modeling, default frequency has been found to depend on several firm-specific factors, most notably credit rating. But aggregate default rates also vary substantially over time, presumably reflecting changes in general economic conditions. In this paper, we...

Value at Risk and similar measures of financial risk exposure require predicting the tail of an asset returns distribution. Assuming a specific form, such as the normal, for thedistribution, the standard deviation (and possibly other parameters) are estimated from recent historical data and the...

In modern finance, the value of an active investment strategy is measured by comparing its performance against the benchmark of passively holding the market portfolio and the riskless asset. We wish to evaluate the marginal contribution of a theoretical derivatives pricing model in the same way,...

The quot;leverage effectquot; refers to the well-established relationship between stock returns and both implied and realized volatility: volatility increases when the stock price falls. A standard explanation ties the phenomenon to the effect a change in market valuation of a firm's equity has...

Trading in derivatives involves heavy use of quantitative models for valuation and risk management. These models are necessarily imperfect, and when options are involved, the models require a volatility input that must be forecasted, subject to error. This creates quot;model riskquot; to which...

Many exotic derivatives do not have closed-form valuation equations, and must be priced using approximation methods. Where they can be applied, standard lattice techniques based on binomial and trinomial trees will achieve correct valuations asymptotically. They can also generally handle...

Do option investors rationally exercise their options? Numerous studies report evidence of irrational behavior. In this paper, we pay careful attention to intraday option quotes and reach the opposite conclusion. An exercise boundary violation (EBV) occurs when the best bid price for an American...

Theory says an American call should never be exercised early, except possibly just before an ex-dividend date. But the best market bid is frequently below intrinsic value for an in-the-money short maturity option. An American option can always be exercised to recover intrinsic value, while...

In modern finance, the value of an active investment strategy is measured by comparingits performance against the benchmark of passively holding the market portfolio and the riskless asset. We wish to evaluate the marginal contribution of a theoretical derivatives pricing model in the same way,...