Download This PaperA Simple and Reliable Way to Compute Option-Based Risk-Neutral Distributions
42 Pages Posted: 14 Jun 2014
Date Written: June 1, 2014
Abstract
This paper describes a method for computing risk-neutral density functions based on the option-implied volatility smile. Its aim is to reduce complexity and provide cookbook-style guidance through the estimation process. The technique is robust and avoids violations of option no-arbitrage restrictions that can lead to negative probabilities and other implausible results. I give examples for equities, foreign exchange, and long-term interest rates.
Keywords: option pricing, risk-neutral distributions
JEL Classification: G01, G13, G17, G18
Suggested Citation: Suggested Citation
Malz, Allan M., A Simple and Reliable Way to Compute Option-Based Risk-Neutral Distributions (June 1, 2014). FRB of New York Staff Report No. 677, Available at SSRN: https://ssrn.com/abstract=2449692 or http://dx.doi.org/10.2139/ssrn.2449692
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