A Semiparametric Estimation of Liquidity Effects on Option Pricing

  1. Ferreira García, Eva
  2. Gago García, Mónica
  3. Rubio Irigoyen, Gonzalo
Journal:
Documentos de Trabajo BILTOKI

ISSN: 1134-8984

Year of publication: 1999

Issue: 8

Type: Working paper

More publications in: Documentos de Trabajo BILTOKI

Abstract

This paper proposes a semiparametric option pricing model with liquidity, as proxied by the relative bid-ask spread. The nonparametric volatility function with liquidity as an explanatory variable is estimated using the Symmetrized Nearest Neighbors (SNN) estimator rather than the traditional kernel estimator. Moreover, special care is taken in obtaining the smoothing parameter. The in-sample performance of the model turns out to be statistically favorable relative to a competing model without liquidity. However, the out-of-sample performance of both models is quite disappointing despite the fact that we are not to reject the stability of risk-neutral densities estimated over different quarters during our sample period.