PRICING MULTIVARIATE CONTINGENT CLAIMS USING ESTIMATED RISK-NEUTRAL DENSITY-FUNCTIONS

Many asset price series exhibit time-varying volatility, jumps and oth er features inconsistent with assumptions about the underlying price p rocess made by standard multivariate contingent claims (MVCC) pricing models. This article develops an interpolative technique for pricing M VCCs - flexible NLS pricing - that involves the estimation of a flexib le multivariate risk-neutral density function implied by existing asse t prices. As an application, the flexible NLS pricing technique is use d to value several bivariate contingent claims dependent on foreign ex change rates in 1993 and 1994. The bivariate flexible risk-neutral den sity function more accurately prices existing options than the bivaria te log-normal density implied by a multivariate geometric Brownian mot ion. In addition, the bivariate contingent claims analyzed have substa ntially different prices using the two density functions suggesting fl exible NLS pricing may improve accuracy over standard methods. (C) 199 8 Elsevier Science B.V. All rights reserved.