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Forecasting Characteristic of the Market of the Underlying Asset, Using Option Prices

Student: Stepantsov Alexandr

Supervisor: Sergey V. Kurochkin

Faculty: Faculty of Economic Sciences

Educational Programme: Financial Markets and Financial Institutions (Master)

Final Grade: 9

Year of Graduation: 2016

In this paper, the theoretical fundamentals of deriving the true matrix of transition probabilities of values of the S&P500 index from one market state to another were reviewed. The basis of this paper is Steve Ross “Recovery Theorem”. Applying interpolation methods to the option volatility surface at a certain date, the theoretical prices of call options with given strikes and maturities were derived. Moving from these call prices to the prices of Arrow-Debreu securities, and by applying an optimization procedure with constraints, the transition matrix of Arrow-Debreu securities was derived. Applying “Recovery Theorem” to this matrix, the true matrix of transition probabilities of the values of the S&P500 index from one market state to another was derived.

Full text (added May 15, 2016)

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