1 - Background note - Dec 1999

Starting in the late 1980s, financial and economic researchers became increasingly sophisticated in their attempts to analyze market expectations embedded in option prices. Moving beyond the study of implied Black-Scholes volatilities, this body of work has focused on the recovery of either the stochastic process followed by the underlying asset price or the density function from which the asset price at expiration will be drawn. The workshop was meant to share information and results on the latter exercise, the estimation of terminal (at expiration) probability density functions (PDFs) implied by option prices. Toward that end, this note is meant to provide some context reading the papers presented at the workshop. The first section of the note provides a brief overview (taxonomy) of the various methods used to estimate PDFs. The second section discusses issues of interpretation, providing an initial exploration of possible lines for future research.