The information content of risk-neutral densities: tests based on Hungarian currency option-implied densities

In this paper we test the information content of risk-neutral density functions estimated by the method of Malz [1997. Estimating the probability distribution of the future exchange rate from options prices. Journal of Derivatives 5, no. 2: 18-36]. The main question is whether risk-neutral densities coincide with the subjective densities. We find that the forecasting ability of 1-month EUR/HUF risk-neutral densities can be rejected for the period 2003-2007. Higher moments are responsible for the poor forecasting ability. Our interpretation is that the standard deviation, the skewness and the kurtosis of the risk-neutral densities are significantly above the respective central moments of subjective densities. We also find that delta-hedged gains on purchased options are negative, and can be considered high compared with the transaction costs of delta hedging.