Risk Neutral Density Estimation: Looking at the Tails

Reinke (2020) compares two methods to estimate option implied risk neutral densities (RND) and looks at their ability to match implied volatilities in the market. Especially deep out of the money options that lie in the tails of the distribution are considered which have been usually excluded from the estimation process.

Literature

Figlewski, S. “Estimating the Implied Risk Neutral Density for the U.S. Market Portfolio.” In: Volatility and Time Series Econometrics: Essays in Honor of Robert F. Engle. ed. T. Bollerslev, J.R. Russell, and M. Watson. UK: Oxford, University Press. 2010.

Jackwerth, J. C. “Option-Implied Risk-Neutral Distributions and Risk Aversion” (2004), Research Foundation of AIMR, Charlottesville, VA, ISBN 0-943205-66-2.

Reinke, M. “Risk Neutral Density Estimation: Looking at the Tails.” The Journal of Derivatives Spring 2020