Risk-adjusted option-implied moments

Felix Brinkmann and Olaf Korn

No 14-07, CFR Working Papers from University of Cologne, Centre for Financial Research (CFR)

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.

Keywords: option-implied moments; risk adjustment; variance risk premium; market risk premium; disappointment aversion (search for similar items in EconPapers)
JEL-codes: C51 C53 G13 G17 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-rmg and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfrwps:1407

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