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Implied risk aversion and volatility risk premiums

Listed author(s):
  • Sun-Joong Yoon
  • Suk Joon Byun
Registered author(s):

    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.

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    Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

    Volume (Year): 22 (2012)
    Issue (Month): 1 (January)
    Pages: 59-70

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    Handle: RePEc:taf:apfiec:v:22:y:2012:i:1:p:59-70
    DOI: 10.1080/09603107.2011.597723
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