The Federal Reserve Board eagle logo links to home page

International Finance Discussion Papers
The International Finance Discussion Papers logo links to the International Finance Discussion Papers home page Using Options Prices to Infer PDF's for Asset Prices: An Application to Oil Prices during the Gulf Crisis
William R. Melick and Charles P. Thomas

Abstract:  We develop a general method to infer martingale equivalent probability density functions (PDFs) for asset prices using American options prices. The early exercise feature of American options precludes expressing the option price in terms of the PDF of the price of the underlying asset. We derive tight bounds for the option price in terms of the PDF and demonstrate how these bounds, together with observed option prices, can be used to estimate the parameters of the PDF. We infer the distribution for the price of crude oil during the Persian Gulf crisis and find the distribution differs significantly from that recovered using standard techniques.

Full paper (3002 KB PDF)

PDF files: Adobe Acrobat Reader   ZIP files: PKWARE

Home | IFDPs | List of 1996 IFDPs
To comment on this site, please fill out our feedback form.
Last update: July 19, 2001