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Matching distributions: Recovery of implied physical densities from option prices

Jarno Talponen

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Abstract: We introduce a non-parametric method to recover physical probability distributions of asset returns based on their European option prices and some other sparse parametric information. Thus the main problem is similar to the one considered foir instance in the Recovery Theorem by Ross (2015), except that here we consider a non-dynamical setting. The recovery of the distribution is complete, instead of estimating merely a finite number of its parameters, such as implied volatility, skew or kurtosis. The technique is based on a reverse application of recently introduced Distribution Matching by the author and is related to the ideas in Distribution Pricing by Dybvig (1988) as well as comonotonicity.

Date: 2018-03
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Handle: RePEc:arx:papers:1803.03996