pdf extraction from traded options

wagrer · July 27th, 2009, 12:14 pm

Is there a simple way to extract an estimate of the pdf of eurodollar futures prices based on traded puts and calls in the market?

Martinghoul · July 27th, 2009, 2:31 pm

There's a whole lotta papers on the subject... There's a simple way and its various complications. Google 'risk neutral distribution' and ye shall find (although I am not sure it's the exact thing you're looking for).As an example, see below for some work on the subject (even though it's not Eurodollars, the idea's the same). Problem is that I can't seem to find any of the original papers any more. FedFunds Rate Predictions

Gmike2000 · July 28th, 2009, 7:09 pm

the simple way is to take the ATM vol and construct a normal distribution around the forward.this is much more stable and just as good (and useless for anything but academia) as any of the fancy methods out there. believe me, i have tried them all.

hopschwyz · July 28th, 2009, 8:23 pm

butterfly prices mapped against strike.

alvinkam · August 1st, 2009, 12:10 pm

That's right, in other words, pdf is proportional to the second derivative of call price with respect to strike. But you only get terminal distributions, nothing about the conditionals from european options.

Gmike2000 · August 3rd, 2009, 8:20 pm

guys, you dont have enough options to get a smooth distribution in the tailsespecially in the wings, where the exchange mandates a minimum tick size....so the option is worth close to zero, but gets marked at min 1 cent. try to imply a tail distribution from a way far out of the money option that gets marked at 1cent...good luckso, stick to the normal distribution around the forward. it don't get better than this.you won't be able to brag about this "model" at a cocktail party, but it gets the job done.