Faced with the problem of pricing complex contingent claims, investors seek to make their valuations robust to model uncertainty. We construct a notion of a modeluncertainty-induced utility function and show that model uncertainty increases investors' effective risk aversion. Using this utility...

The traditional derivation of risk-neutral probability in the binomial option pricing framework used in introductory mathematical finance courses is straightforward, but employs several different concepts and is is not algebraically simple. In order to overcome this drawback of the standard...

This paper presents a set of probability density functions for Euribor outturns in three months’ time, estimated from the prices of options on Euribor futures. It is the first official and freely available dataset to span the complete history of Euribor futures options, thus comprising over...

The prices of derivatives contracts can be used to estimate ‘risk-neutral' probability density functions that give an indication of the weight investors place on different future prices of their underlying assets, were they risk-neutral. In the likely case that investors are risk-averse, this...

This paper contributes a generic probabilistic method to derive explicit exact probability densities for stochastic volatility models. Our method is based on a novel application of the exponential measure change in Palmowski & Rolski (2002). With this generic approach, we first derive explicit...

This paper presents a set of probability density functions for Euribor outturns in three months' time, estimated from the prices of options on Euribor futures. It is the first official and freely available dataset to span the complete history of Euribor futures options, thus comprising over ten...

This paper proposes a general method to recover the subjective probability distribution of nonlinear payoffs from option prices. We show that the characteristic function of the distribution can be represented as the present value of a static option portfolio with complex-valued portfolio...

All too often, the concept of risk-neutral probabilities in mathematical finance is poorly explained, and misleading statements are made. The aim of this paper is to provide an intuitive understanding of risk-neutral probabilities, and to explain in an easily accessible manner how they can be...

We study discretizations of polynomial processes using finite state Markov processes satisfying suitable moment matching conditions. The states of these Markov processes together with their transition probabilities can be interpreted as Markov cubature rules. The polynomial property allows us to...

Cumulative prospect theory (CPT) has been proposed as an alternative to expected utility theory to explain irregular behavior by economic agents. CPT comprises two key transformations: one of outcome values and the other of objective probabilities. Risk attitudes are derived from the shapes of...