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Inverse Learning of Latent Risk-Neutral Densities from Irregular Option Quotes

Machine Learning 2026-07-29 v1 Computational Finance Pricing of Securities Statistical Finance

Abstract

Accurate option prices do not imply accurate recovery of the latent risk-neutral density. We study this distinction with two complementary benchmarks. A controlled benchmark exposes simulator-truth densities for latent evaluation, while a chronological NIFTY benchmark tests only held-out market prices. A two-component lognormal mixture has the lowest aggregate price, L1L^1, Wasserstein, and fixed-tail errors on the synthetic benchmark. Learned operators retain narrower strengths: DeepONet reduces 1% quantile and variance error by 39.0% and 34.6% relative to the mixture, and a quote transformer reduces L1L^1 by 16.4% on the structurally misspecified Merton family. A numerical conditioning analysis explains why these rankings can differ: after enforcing mass and forward constraints, 95 of 126 pricing directions are numerically null, and two densities separated by L1=0.061L^1 = 0.061 produce identical prices on the covered strikes. On 524 held-out NIFTY calls, validation-selected test-time adaptation reduces DeepONet RMSE by 28.3%, but per-expiry mixture and SVI fits remain much more accurate. The evidence supports target-dependent inductive bias, not a universal winner.

Keywords

Cite

@article{arxiv.2607.27188,
  title  = {Inverse Learning of Latent Risk-Neutral Densities from Irregular Option Quotes},
  author = {Lennon J. Shikhman and Michael Galarnyk and Aadi Dash and Nicholas A. Welsh},
  journal= {arXiv preprint arXiv:2607.27188},
  year   = {2026}
}

Comments

7 pages, 4 figures, 2 tables. Submitted to the 7th ACM International Conference on AI in Finance (ICAIF 2026)