DP12883 Options and the Gamma Knife

Author(s): Ian Martin
Publication Date: April 2018
Keyword(s): Arrow-Debreu securities, Derivatives, gamma knife, Option prices, Radon transform, risk-neutral distribution, SVIX, VIX
JEL(s): G10, G12, G13
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12883

I survey work of Steve Ross (1976) and of Douglas Breeden and Robert Litzenberger (1978) that first showed how to use options to synthesize more complex securities. Their results made it possible to infer the risk-neutral measure associated with a traded asset, and underpinned the development of the VIX index. The other main result of Ross (1976), which shows how to infer joint risk-neutral distributions from option prices, has been much less influential. I explain why, and propose an alternative approach to the problem. This paper is dedicated to Steve Ross, and was written for a special issue of the Journal of Portfolio Management in memory of him.