No abstract

Section 1 of this online appendix shows that in a Black-Scholes economy there is an optimal generalized entropic estimator correctly pricing any option. This estimator is determined by the parameters governing risk premium in the underlying asset process. Section 2 contains additional empirical results on the performance of generalized entropic estimators for pricing S&P 500 options and U.S. individual equity options, complementing the analysis in the main paper.

Implicit in interest rate derivatives are Arrow-Debreu prices (or state price densities, SPDs) that contain fundamental information for risk and portfolio management in interest rate markets. To extract such information from interest rate derivatives, we propose a nonparametric method to estimate state prices based on the minimization of the Cressie-Read (Entropic) family function between potential SPDs and the empirical probability measure. An empirical application of the method, in the US interest rates and derivatives market, shows that the entropic based risk-neutral density measure highlight potential risks previous to the 2007/2008 financial crisis, and the potential arbitrage burden during the Quantitative Easing period.