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Implied risk aversion and volatility risk premiums


  • Sun-Joong Yoon
  • Suk Joon Byun


Since investor risk aversion determines the premium required for bearing risk, a comparison thereof provides evidence of the different structure of risk premium across markets. This article estimates and compares the degree of risk aversion of three actively traded options markets: the S&P 500, Nikkei 225 and KOSPI 200 options markets. The estimated risk aversions is found to follow S&P 500, Nikkei 225 and KOSPI 200 options in descending order, implying that S&P 500 investors require more compensation than other investors for bearing the same risk. To prove this empirically, we examine the effect of risk aversion on volatility risk premium, using delta-hedged gains. Since more risk-averse investors are willing to pay higher premiums for bearing volatility risk, greater risk averseness can result in a severe negative volatility risk premium, which is usually understood as hedging demands against the underlying asset's downward movement. Our findings support the argument that S&P 500 investors with higher risk aversion pay more premiums for hedging volatility risk.

Suggested Citation

  • Sun-Joong Yoon & Suk Joon Byun, 2012. "Implied risk aversion and volatility risk premiums," Applied Financial Economics, Taylor & Francis Journals, vol. 22(1), pages 59-70, January.
  • Handle: RePEc:taf:apfiec:v:22:y:2012:i:1:p:59-70
    DOI: 10.1080/09603107.2011.597723

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