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Risk-adjusted option-implied moments

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  • Brinkmann, Felix
  • Korn, Olaf

Abstract

Option-implied moments, like implied volatility, contain useful information about an underlying asset's return distribution, but are derived under the risk-neutral probability measure. This paper shows how to convert risk-neutral moments into the corresponding physical ones. The main theoretical result expresses moments under the physical probability measure in terms of observed option prices and the preferences of a representative investor. Based on this result, we investigate several empirical questions. We show that a model of a representative investor with CRRA utility can explain the variance risk premium for the S&P500 index but fails to capture variance and skewness risk premiums simultaneously. Moreover, we present methods to estimate forward-looking market risk premiums and investors' disappointment aversion implied in market prices.

Suggested Citation

  • Brinkmann, Felix & Korn, Olaf, 2014. "Risk-adjusted option-implied moments," CFR Working Papers 14-07, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:1407
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    option-implied moments; risk adjustment; variance risk premium; market risk premium; disappointment aversion;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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