@article{49d8ce1bfad040d0bdfbf5d4b1d422e4,
title = "The risk premia embedded in index options",
abstract = "We study the dynamic relation between market risks and risk premia using time series of index option surfaces. We find that priced left tail risk cannot be spanned by market volatility (and its components) and introduce a new tail factor. This tail factor has no incremental predictive power for future volatility and jump risks, beyond current and past volatility, but is critical in predicting future market equity and variance risk premia. Our findings suggest a wide wedge between the dynamics of market risks and their compensation, which typically displays a far more persistent reaction following market crises.",
keywords = "Extreme events, Jumps, Option pricing, Return predictability, Risk aversion, Risk premia, Stochastic volatility",
author = "Andersen, {Torben G.} and Nicola Fusari and Viktor Todorov",
note = "Funding Information: We are grateful to Bill Schwert (the editor), David Bates (the referee), and Snehal Banerjee, Geert Bekaert, Peter Carr, Anna Cieslak, Bjorn Eraker, Kay Giesecke, Ravi Jagannathan, Bryan Kelly [our discussant at the National Bureau of Economic Research (NBER) meeting], Robert Merton, Toby Moskowitz, Lasse Pedersen, Sergio Rebelo, Myron Scholes, Ivan Shaliastovich (our discussant in Montreal, Canada), Allan Timmermann, Jonathan Wright, and Liuren Wu, as well as seminar participants at Kellogg School of Management, Northwestern University, Duke University, the {\textquoteleft}Montreal 2013 Econometrics Conference: Time Series and Financial Econometrics,{\textquoteright} the 40th Annual Meeting of the Danish Econometric Society, Sandbjerg, Denmark, the European University Institute, Florence, Italy 2013 Workshop on {\textquoteright}Measuring and Modeling Financial Risk and High Frequency Data׳, the 2013 {\textquoteleft}International Conference in Financial Econometrics{\textquoteright} at Shandong University, Jinan, China, the {\textquoteleft}40 Years after the Black-Scholes-Merton Model{\textquoteright} conference at the Stern School of Business (October 2013), the NBER Asset Pricing Meeting at Stanford University (November 2013), Georgia Tech, Boston University, Stanford University, the Insight Award Conference, sponsored by AQR Capital Management, Greenwich, Connecticut (April 2014), the 2014 Annual Society for Financial Econometrics (SoFiE) Meeting, Toronto, Canada, the 2014 Australasian Econometric Society Meetings, Tasmania, Australia, the 2014 NBER Summer Institute Forecasting, and Empirical Methods Meeting, and the 2014 European Finance Association (EFA) meeting, Lugano, Switzerland, for helpful comments. Torben G. Andersen gratefully acknowledges support from CREATES, Center for Research in Econometric Analysis of Time Series (DNRF78), funded by the Danish National Research Foundation. Viktor Todorov׳s work was partially supported by National Science Foundation Grant SES-0957330 . Publisher Copyright: {\textcopyright} 2015 Elsevier B.V.",
year = "2015",
month = sep,
day = "1",
doi = "10.1016/j.jfineco.2015.06.005",
language = "English (US)",
volume = "117",
pages = "558--584",
journal = "Journal of Financial Economics",
issn = "0304-405X",
publisher = "Elsevier",
number = "3",
}