Abstract
We explore the pricing of tail risk as manifest in index options across international equity markets. The risk premium associated with negative tail events displays persistent shifts, unrelated to volatility. This tail risk premium is a potent predictor of future returns for all the indices, while the option-implied volatility only forecasts the future return variation. Hence, compensation for negative jump risk is the primary driver of the equity premium, whereas the reward for pure diffusive variance risk is unrelated to future equity returns. We also document pronounced commonalities, suggesting a high degree of integration among the major global equity markets. KEY WORDS: Equity risk premium; International option markets; Predictability; Tail risk; Variance risk premium.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 662-678 |
| Number of pages | 17 |
| Journal | Journal of Business and Economic Statistics |
| Volume | 38 |
| Issue number | 3 |
| DOIs | |
| State | Published - Jul 2 2020 |
Funding
Andersen gratefully acknowledges support from CREATES, Center for Research in Econometric Analysis of Time Series (DNRF78), funded by the Danish National Research Foundation. The work is partially supported by NSF Grant SES-1530748. We thank the editor, Todd Clark, the associate editor, and two anonymous referees for many useful comments and suggestions. We thank Eben Lazarus for providing the code used to implement the HAR estimators in Lazarus et al. (2018). We also thank participants at the following presentations for useful comments: AQR Capital Management; Midwest Finance Association Meeting 2016, Chicago; Key-note address at the 2016 Nippon Finance Association Meeting, Yokohama; 30th Anniversary of GARCH Models and Measures Conference, Toulouse School of Economics; Key-note address at the Financial Econometrics and Empirical Asset Pricing Conference 2016, Lancaster University Management School; SoFiE Annual Meeting 2016, City University, Hong Kong; NBER Summer Institute 2016; Financial Econometrics Conference 2016, Questrom School of Business, Boston University; CBOE Conference on Volatility and Derivatives 2016, Chicago; Financial Econometrics Conference 2016, Rio de Janeiro; as well as participants at numerous seminars.
ASJC Scopus subject areas
- Statistics and Probability
- Social Sciences (miscellaneous)
- Economics and Econometrics
- Statistics, Probability and Uncertainty