The forecasting ability of implicit risk-neutral density function: A study of planned economic events in Sweden

University essay from Handelshögskolan i Stockholm/Institutionen för finansiell ekonomi

Abstract: Financial institutions spend large amounts of money on gaining accurate information. The information they acquire is often kept for themselves and used in order to trade and make profits. When they use the information it is though implicitly put into the prices of the instruments. This because they price the instruments on the information they have. In this thesis option prices are used in order to derive the underlying information that the financial institutions used to price them. Explicitly, the implicit Risk-Neutral Density (RND) is derived from option prices close to planned economic events, and the shape of this function is studied and interpreted. In practise, the Swedish election of 2006 and Swedish Central Bank meetings are studied in order to forecast the outcomes of these events. The result is that the RND changed drastically around the election, but the implications of these changes are uncertain. For the Central bank meetings the result was that it was not possible to forecast the outcomes of any of these meetings.

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