2018/09/27 by Stephen Figlewski · 74 citations
Economics, Econometrics and Finance · #Financial Markets and Investment Strategies #Stochastic processes and financial applications #Financial Risk and Volatility Modeling #Financial economics #Volatility (finance) #Economics #Equity (law) #Risk neutral #Positive economics #Actuarial science #Political science
paper · doi:10.1146/annurev-financial-110217-022944
published in Annual Review of Financial Economics 10(1), 329-359 (Annual Reviews)
openalex publication_date 2018/09/27 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/31
Trading in options with a wide range of exercise prices and a single maturity allows a researcher to extract the market's risk-neutral density (RND) over the underlying price at expiration. The RND contains investors’ beliefs about the true probabilities blended with their risk preferences, both of which are of great interest to academics and practitioners alike. With a particular focus on US equity options, I review the historical development of this powerful concept, practical details of fitting an RND to options market prices, and the many ways in which investigators have tried to distill true expectations and risk premia from observed RNDs. I briefly discuss areas of active current research including the pricing kernel puzzle and the volatility surface, and offer thoughts on what has been learned about RNDs so far and fruitful directions for future research.