Extracting Risk-Neutral Probability Distributions from Option Prices Using Trading Volume as a Filter

Dominique Y. Dupont
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Dominique Y. Dupont: EURANDOM - TUE, The Netherlands

No 104, Economics Series from Institute for Advanced Studies

Abstract: This paper introduces a new technique to infer the risk-neutral probability distribution of an asset from the prices of options on this asset. The technique is based on using the trading volume of each option as a proxy of the informativeness of the option. Not requiring the implied probability distribution to recover exactly the market prices of the options allows us to weight each option by a function of its trading volume. As a result, we obtain implied probability distributions that are both smoother and should be more reflective of fundamentals.

Keywords: Implied risk-neutral probability distribution; Implied-tree method (search for similar items in EconPapers)
JEL-codes: G13 G14 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2001-09
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Citations: View citations in EconPapers (6)

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https://irihs.ihs.ac.at/id/eprint/1367 First version, 2001 (application/pdf)

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