Using option prices to measure financial market views about balances of risk to future asset prices

Quarterly Bulletin 2004 Q4
Published on 17 December 2004

By Damien Lynch and Nikolaos Panigirtzoglou of the Bank's Monetary Instruments and Markets Division and George Kapetanios of the Bank's Conjunctural Assessment and Projections Division. 

Probability density functions (pdfs), implied by prices of traded options, are often used by the Bank to examine financial market expectations about future levels of different asset prices. This article examines how information about one aspect of such expectations - views on balances of risk - for future asset prices may be inferred from the degree of asymmetry of an implied pdf. We first look at the general issue of choosing a statistic to summarise the degree of asymmetry of any pdf. The choice of units when measuring changes in the underlying asset price is then considered. Finally, we examine empirically the implications of using various asymmetry measures when relating the information from option-implied pdfs to market views about balances of risk to future asset prices.

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