A New Method of Employing the Principle of Maximum Entropy to Retrieve the Risk Neutral Density

This paper suggests a new method of implementing the principle of maximum entropy to retrieve the risk neutral density of future stock, or any other asset, returns from European call and put prices. Instead of option prices, the method employs risk neutral moments as constraints. These moments can be retrieved from market option prices in a first step. Compared to other existing methods of retrieving the risk neutral density based on the principle of maximum entropy, the benefits of the method that the paper suggests is the use of all the available information provided by the market more sufficiently. To evaluate the performance of the suggested method, the paper presents simulation and empirical evidence.