Probability distributions of future asset prices implied by option prices

Quarterly Bulletin 1996 Q3
Published on 01 September 1996

By Bhupinder Bahra of the Bank’s Monetary Instruments and Markets Division.

The most widely used measure of the market’s views about the future value of an asset is the mean or average price expectation—a point estimate. This article shows how this information set can be extended by using option prices to estimate the market’s entire probability distribution of a future asset price. It also illustrates the potential value of this type of information to the policy-maker in assessing monetary conditions, monetary credibility, the timing and effectiveness of monetary operations, and in identifying anomalous market prices. Finally, the article looks at the limitations in data availability and details some areas for future research.

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