Estimating the Probability Distribution of the Future Exchange Rate from Option Prices

A paper describes a method of extracting the risk-neutral probability distribution of future exchange rates from option prices. In foreign exchange markets, interbank option pricing conventions facilitate reliable inferences about risk-neutral probability distributions with a small amount of readily...

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Bibliographic Details
Published in:The Journal of derivatives 1997-12, Vol.5 (2), p.18-36
Main Author: Malz, Allan M.
Format: Article
Language:English
Subjects:
Derivatives
Economic models
Foreign exchange markets
Foreign exchange rates
Probability
Probability distribution
Risk assessment
Securities prices
Volatility
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Summary:A paper describes a method of extracting the risk-neutral probability distribution of future exchange rates from option prices. In foreign exchange markets, interbank option pricing conventions facilitate reliable inferences about risk-neutral probability distributions with a small amount of readily available information. The risk-neutral probability distribution of the future exchange rate provides investors and market analysts with an important tool for gauging market sentiment.
ISSN:1074-1240
2168-8524
DOI:10.3905/jod.1997.407988