The risk premia embedded in index options

Torben G. Andersen, Nicola Fusari*, Viktor Todorov

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

62 Scopus citations

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.

Original languageEnglish (US)
Pages (from-to)558-584
Number of pages27
JournalJournal of Financial Economics
Volume117
Issue number3
DOIs
StatePublished - Sep 1 2015

Keywords

  • Extreme events
  • Jumps
  • Option pricing
  • Return predictability
  • Risk aversion
  • Risk premia
  • Stochastic volatility

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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