Extracting risk-neutral probability distribution from Brent oil options

Vugar Ahmadov, Salman Huseynov (), Fuad Mammadov () and Tural Karimli ()
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Vugar Ahmadov: Central Bank of Azerbaijan Republic
Salman Huseynov: Central Bank of Azerbaijan Republic
Fuad Mammadov: Central Bank of Azerbaijan Republic
Tural Karimli: Central Bank of Azerbaijan Republic

No 1506, Working Papers from Central Bank of Azerbaijan Republic

Abstract: In this study, we estimate a risk-neutral implied probability distribution using American call (put) options on Brent oil futures. For this purpose, we apply three different methodologies: non-parametric approach (kernel density estimation), semi-parametric approach by Shimko (1997), Datta and others (2014) and parametric approach by Bahra (1997), Melik and Tomas (1997). One advantage of probability distribution estimation is that besides providing us with average market expectation, it also helps to calculate different moments and attach probabilities to oil price expectations. This study intends to develop a necessary toolbox for policymakers to undertake different case study analysis that will facilitate decision-making process and helps them to promptly address the global shocks. As examples for the case studies, we examine impacts of Yemen - Saudi Arabia (airstrike) conflict and 166th OPEC meeting decisions on oil price expectations. We show that the methodologies employed for the estimations of implied probability distribution and case study analysis deliver plausible and convincing results. Note that, albeit study covers estimations of oil price expectations, employed methodology can be easily applied to other financial markets, i.e., international exchange market or LIBOR to assess expectations.

Keywords: Oil option prices; risk neutral probability distribution (search for similar items in EconPapers)
JEL-codes: C25 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2015-03-20
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Persistent link: https://EconPapers.repec.org/RePEc:aze:wpaper:1506

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