There is a close link between prices of equity options and the default probability of a firm. We show that in the presence of positive expected equity recovery, standard methods that assume zero equity recovery at default misestimate the option-implied default probability. We introduce a simple...

We examine the empirical performance of a spline-based, local volatility surface for the period 2000–2005. Our findings indicate that the proposed model outperforms the best-performing implied volatility–based model reported in the current literature for European-style S&P 500 Index options....

Figlewski [2002] has pointed out that there is nothing special about the Black–Scholes equation if the model is used for interpolation. Figlewski introduced a single-parameter alternative function. This function was extended by Henderson, Hobson, and Kluge [2007] to incorporate maturity....

We propose new methodology to evaluate the empirical performance of structural option pricing models. Christoffersen, Jacobs, and Heston (2009) and Orosi (2010) point out that ad hoc models signi ficantly outperform structural models. These results are based on how well the models replicate...

We examine the empirical performance of several stochastic local volatility models that are the extensions of the Heston stochastic volatility model. Our results indicate that the stochastic volatility model with quadratic local volatility significantly outperforms the stochastic volatility...

In this paper, we present a novel method to extract the risk-neutral probability of default of a from from American put option prices. Building on the idea of a default corridor proposed in Carr and Wu (2011), we derive a parsimonious closed-form formula for American put option price from which...

There is a close link between prices of equity options and the probability of default of a firm. We show that in the presence of positive expected equity recovery, the standard methods that assume zero equity recovery at default misestimate the probability of default implicit in option prices....

In this study, we investigate how useful the information content of out-of-the-money S&P 500 index call options is to predict the size and direction of the underlying index for the period 2004-2013. First, we demonstrate that behavior of the right tail of the option implied risk-neutral...

The traditional derivation of risk-neutral probability in the binomial option pricing framework used in introductory mathematical finance courses is straightforward, but employs several different concepts and is is not algebraically simple. In order to overcome this drawback of the standard...

In this paper, we propose a novel parametric approach to extract the implied risk-neutral density function from a cross-section of call option prices. The method is based on the framework proposed by Orosi (2011), who presents a multi-parameter extension of the models of Figlewski (2002) and...