In this paper we present a new methodology to infer the implied risk-neutral distribution function from European-style options. We introduce a skewed version of the Student-t distribution, whose main advantage is that its shape depends on only four parameters, of which two directly control for the levels of skewness and kurtosis. We can thus easily vary parameters to compare different distributions and use the parameters as inputs to price other options. We explain the method, provide some empirical results and compare them with the results of alternative models. The results indicate that our model provides a better fit to market prices of options than the Shimko or implied tree models, and has a lower computation time than most other models. We conclude that the skewed Student-t method provides a good alternative for European-style options.

implied distribution, implied volatility, options, skewness, student-t
Econometric and Statistical Methods: Special Topics: General (jel C40), Contingent Pricing; Futures Pricing (jel G13), Business Administration and Business Economics; Marketing; Accounting (jel M)
Erasmus Research Institute of Management
hdl.handle.net/1765/21
ERIM Report Series Research in Management
Copyright 2000, C. de Jong, R. Huisman, This report in the ERIM Report Series Research in Management is intended as a means to communicate the results of recent research to academic colleagues and other interested parties. All reports are considered as preliminary and subject to possibly major revisions. This applies equally to opinions expressed, theories developed, and data used. Therefore, comments and suggestions are welcome and should be directed to the authors.
Erasmus Research Institute of Management

de Jong, C.M, & Huisman, R. (2000). From Skews to a Skewed-t (No. ERS-2000-12-F&A). ERIM Report Series Research in Management. Erasmus Research Institute of Management. Retrieved from http://hdl.handle.net/1765/21