Simple and reliable way to compute option-based risk-neutral distributions

Allan M. Malz

No 677, Staff Reports from Federal Reserve Bank of New York

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 (search for similar items in EconPapers)
JEL-codes: G01 G13 G17 G18 (search for similar items in EconPapers)
Date: 2014-06-01
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Citations: View citations in EconPapers (16)

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