Why Option Prices Do Not Directly Reveal Physical Probabilities

Summary

The document raises the problem of converting probabilities inferred from stock option prices under a risk-neutral measure into real-world, or physical, probabilities. Its only proposed method is the Recovery Theorem, named in a brief answer. No derivation, assumptions, implementation steps, or supporting evidence are supplied, so the note offers a pointer rather than a usable conversion procedure.

The distinction matters because option prices reflect risk-neutral valuation, whereas physical probabilities describe outcomes under the real-world measure. The document does not explain how the theorem recovers a distribution or what market inputs and conditions it requires. Readers would need additional sources before applying the suggestion or evaluating its limitations.

Key ideas

• Option prices imply risk-neutral probabilities, which differ from physical probabilities.
• The Recovery Theorem is suggested as a way to infer a physical distribution.
• The document provides no derivation or practical details for applying the theorem.

Tags

# Physical Option Implied Distribuition


# Physical Option Implied Distribuition












So I got risk neutral probabilities from stock option prices. How can I then map them to a physical measure?

## Answer by Ryogi (score 0, accepted)

https://quant.stackexchange.com/a/9139

You can use the Recovery Theorem.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.