Entropy Concepts Applied to Option Pricing

Radu Tunaru

Abstract


Uncertainty is one of the most important concept in financial mathematics applications. In this paper we review some important aspects related to the application of entropy-related concepts to option pricing. The Kullback-Leibler information divergence and the informational energy introduced by Onicescu are the main tools investigated in this paper. We highlight a necessary condition that must be verified when obtaining the probability distribution minimising the Kullback-Leibler information divergence. Deriving a probability distribution by optimising the information energy has some pitfalls that are discussed in this paper.

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