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A simple and reliable way to compute option-based risk-neutral distributions

By Allan M. Malz

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 impla usible results. I give examples for equities, foreign exchange, and long-term interest rates

Topics: G01, G13, G17, G18, ddc:330, option pricing, risk-neutral distributions
Publisher: New York, NY: Federal Reserve Bank of New York
Year: 2014
OAI identifier: oai:econstor.eu:10419/120801
Provided by: EconStor

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