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The price of derivative contracts has always played a strategic role in extracting valid information to be employed in one’s own investment strategies. Shimko (1993) was a pioneer in this arena. …
The price of derivative contracts has always played a strategic role in extracting valid information to be employed in one’s own investment strategies. Shimko (1993) was a pioneer in this arena. Taking up where Shimko left off, this paper will demonstrate how to extract Risk neutral density function using two different techniques from derivative contracts. Shimko proposed a technique to build up the risk neutral density function starting by employing the implied volatility smile of 3M Liffe EURIBOR derivative contracts. The procedures adopted here are based on the implementation of an interpolation model, a polynomial splines, applied to the implied volatility smile of future Liffe EURIBOR 3 M from which RNDs will be created. The flexibility of the model, as will be explained, is entirely attributed to the differentiability of the call and put prices found in the BlackScholes model, as well as the lognormality on which the BlackScholes model rests. Finally, the paper will include the impact the Lehman Brothers collapse had on the Future EURIBOR 3 M.
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