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Option-implied objective measures of market risk

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  • Leiss, Matthias
  • Nax, Heinrich H.

Abstract

Foster and Hart (2009) introduce an objective measure of the riskiness of an asset that implies a bound on how much of one’s wealth is ‘safe’ to invest in the asset while (a.s.) guaranteeing no-bankruptcy in the long run. In this study, we translate the Foster-Hart measure from static and abstract gambles to dynamic and applied finance using nonparametric estimation of risk-neutral densities from S&P 500 call and put option prices covering 2003 to 2013. This exercise results in an option-implied market view of objective riskiness. The dynamics of the resulting ‘option-implied Foster-Hart bound’ are analyzed and assessed in light of well-known risk measures including value at risk, expected shortfall and risk-neutral volatility. The new measure is shown to be a significant predictor of ahead-return downturns. Furthermore, it is able to grasp more characteristics of the risk-neutral probability distributions than other measures, furthermore exhibiting predictive consistency. The robustness of the risk-neutral density estimation method is analyzed via a bootstrap.

Suggested Citation

  • Leiss, Matthias & Nax, Heinrich H., 2015. "Option-implied objective measures of market risk," LSE Research Online Documents on Economics 65446, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:65446
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    File URL: http://eprints.lse.ac.uk/65446/
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    References listed on IDEAS

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    1. Robert J. Aumann & Roberto Serrano, 2008. "An Economic Index of Riskiness," Journal of Political Economy, University of Chicago Press, vol. 116(5), pages 810-836, October.
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    Cited by:

    1. Anand, Abhinav & Li, Tiantian & Kurosaki, Tetsuo & Kim, Young Shin, 2016. "Foster–Hart optimal portfolios," Journal of Banking & Finance, Elsevier, vol. 68(C), pages 117-130.

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    More about this item

    Keywords

    risk measure; risk dynamics; risk-neutral densities; vaue at risk; expected shortfall;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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