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Disasters implied by equity index options

  • David Backus
  • Mikhail Chernov
  • Ian Martin

We use prices of equity index options to quantify the impact of extreme events on asset returns. We define extreme events as departures from normality of the log of the pricing kernel and summarize their impact with high-order cumulants: skewness, kurtosis, and so on. We show that high-order cumulants are quantitatively important in both representative-agent models with disasters and in a statistical pricing model estimated from equity index options. Option prices thus provide independent confirmation of the impact of extreme events on asset returns, but they imply a more modest distribution of them.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15240.

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Date of creation: Aug 2009
Date of revision:
Publication status: published as David Backus & Mikhail Chernov & Ian Martin, 2011. "Disasters Implied by Equity Index Options," Journal of Finance, American Finance Association, vol. 66(6), pages 1969-2012, December.
Handle: RePEc:nbr:nberwo:15240
Note: AP EFG
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