Option Implied Risk-Neutral Distributions and Implied Binomial Trees: A Literature Review
17 Pages Posted: 21 Oct 1999 Last revised: 20 Nov 2008
Date Written: September 26, 1999
In this partial and selective literature review of option implied risk-neutral distributions and of implied binomial trees, we start by observing that in efficient markets, there is information contained in option prices, which might help us to design option pricing models. To this end, we review the numerous methods of recovering risk-neutral probability distributions from option prices at one particular time-to-expiration and their applications. Next, we extend our attention beyond one time-to-expiration to the construction of implied binomial trees, which model the stochastic process of the underlying asset. Finally, we describe extensions of implied binomial trees, which incorporate stochastic volatility, as well as other non-parametric methods.
JEL Classification: C14, G13
Suggested Citation: Suggested Citation