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Risk Neutral Measure Determination from Price Ranges: Single Period Market Models

1
Centro de Finanzas, IESA, Caracas 1011, Venezuela
2
Idalion Capital Group, Quantitative Trading, 12 Hay Hill, London W1J 8NR, UK
3
University of the Andes School of Management (Uniandes), Cl. 21 #1-20, Edificio SD, Bogotá, Colombia
*
Author to whom correspondence should be addressed.
Entropy 2018, 20(7), 508; https://doi.org/10.3390/e20070508
Received: 14 May 2018 / Revised: 5 June 2018 / Accepted: 6 June 2018 / Published: 4 July 2018
Risk neutral measures are defined such that the basic random assets in a portfolio are martingales. Hence, when the market model is complete, valuation of other financial instruments is a relatively straightforward task when those basic random assets constitute their underlying asset. To determine the risk neutral measure, it is assumed that the current prices of the basic assets are known exactly. However, oftentimes all we know about the current price, or that of a derivative having it as underlying, is a bid-ask range. The question then arises as to how to determine the risk neutral measure from that information. We may want to determine risk neutral measures from that information to use it, for example, to price other derivatives on the same asset. In this paper we propose an extended version of the maximum entropy method to carry out that task. This approach provides a novel solution to this problem, which is computationally simple and fast. View Full-Text
Keywords: risk neutral measures; maximum entropy with errors in the data; bid-ask prices risk neutral measures; maximum entropy with errors in the data; bid-ask prices
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Gzyl, H.; Molina, G.; Ter Horst, E. Risk Neutral Measure Determination from Price Ranges: Single Period Market Models. Entropy 2018, 20, 508.

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