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Option-Implied Risk Aversion Estimates

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Author Info
Robert R. Bliss
Nikolaos Panigirtzoglou
Abstract

Using a utility function to adjust the risk-neutral PDF embedded in cross sections of options, we obtain measures of the risk aversion implied in option prices. Using FTSE 100 and S&P 500 options, and both power and exponential-utility functions, we estimate the representative agent's relative risk aversion (RRA) at different horizons. The estimated coefficients of RRA are all reasonable. The RRA estimates are remarkably consistent across utility functions and across markets for given horizons. The degree of RRA declines broadly with the forecast horizon and is lower during periods of high market volatility. Copyright 2004 by The American Finance Association.

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Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 59 (2004)
Issue (Month): 1 (02)
Pages: 407-446
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Handle: RePEc:bla:jfinan:v:59:y:2004:i:1:p:407-446

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  1. Gabriele Galati & Patrick Higgins & Owen F. Humpage & William Melick, 2006. "Option prices, exchange market intervention, and the higher moment expectations channel: a user’s guide," Working Paper 0618, Federal Reserve Bank of Cleveland. [Downloadable!]
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  2. Sheri Markose & Amadeo Alentorn, 2005. "Option Pricing and the Implied Tail Index with the Generalized Extreme Value (GEV) Distribution," Computing in Economics and Finance 2005 397, Society for Computational Economics. [Downloadable!]
  3. Pedro Santa-Clara & Shu Yan, 2004. "Jump and Volatility Risk and Risk Premia: A New Model and Lessons from S&P 500 Options," NBER Working Papers 10912, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Marian Micu, 2005. "Extracting expectations from currency option prices: a comparison of methods," Computing in Economics and Finance 2005 226, Society for Computational Economics. [Downloadable!]
  5. Sami Vähämaa, 2004. "Option-implied asymmetries in bond market expectations around monetary policy actions of the ECB," Working Paper Series 315, European Central Bank. [Downloadable!]
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  6. Tim Bollerslev & Hao Zhou, 2006. "Expected stock returns and variance risk premia," Finance and Economics Discussion Series 2007-11, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  7. Peter Christoffersen & Stefano Mazzotta, 2004. "The information content of over-the-counter currency options," Working Paper Series 366, European Central Bank. [Downloadable!]
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  8. John B. Carlson & Ben R. Craig & William R. Melick, 2005. "Recovering market expectations of FOMC rate changes with options on federal funds futures," Working Paper 0507, Federal Reserve Bank of Cleveland. [Downloadable!]
  9. Ruijun Bu & Kaddour Hadri, 2005. "Estimating the Risk Neutral Probability Density Functions Natural Spline versus Hypergeometric Approach Using European Style Options," Research Papers 200510, University of Liverpool Management School. [Downloadable!]
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