1. Estimation of the Asset Price Distribution Using the Maximum Entropy Principle
- Author
-
Geon Ho Choe and Myeong Geun Jeong
- Subjects
Binary entropy function ,Computer Science::Computer Science and Game Theory ,symbols.namesake ,Principle of maximum entropy ,Lagrange multiplier ,Maximum entropy probability distribution ,Economics ,symbols ,Entropy (information theory) ,Maximum entropy spectral estimation ,Joint entropy ,Mathematical economics ,Binary option - Abstract
Option price contains information on the distribution of the underlying asset. Under insufficient condition we employ the maximum entropy principle to estimate the probability density of the asset price. The problem is equivalent to finding the Lagrange multipliers of a linear functional defined by entropy and payoff functions. Buchen and Kelly proved that the maximum entropy distribution recovered from observed option prices is quite similar with the original asset distribution. In this article we apply a similar method to recover the probability density function of an asset from given option prices for binary options and European options.
- Published
- 2008