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Option-implied objective measures of market risk

Matthias Leiss and Heinrich H. Nax

Journal of Banking & Finance, 2018, vol. 88, issue C, 241-249

Abstract: Foster and Hart (2009) introduce an objective measure of the riskiness of an asset that implies a bound on how much of one’s wealth is ‘safe’ to invest in the asset while (a.s.) guaranteeing no-bankruptcy. In this study, we translate the Foster–Hart measure from static and abstract gambles to dynamic and applied finance using nonparametric estimation of risk-neutral densities from S&P 500 call and put option prices covering 2003–2013. The dynamics of the resulting ‘option-implied Foster–Hart bound’ are assessed in light of other well-known option-implied risk measures including value at risk, expected shortfall and risk-neutral volatility, as well as high moments of the densities and several industry measures. Rigorous variable selection reveals that the new measure is a significant predictor of (large) ahead-return downturns. Furthermore, it grasps more characteristics of the risk-neutral probability distributions in terms of moments than other measures and exhibits predictive consistency. The robustness of the risk-neutral density estimation is analyzed via Monte Carlo methods.

Keywords: Risk measure; Risk dynamics; Risk-neutral densities; Value at risk; Expected shortfall (search for similar items in EconPapers)
JEL-codes: D81 D84 G01 G32 (search for similar items in EconPapers)
Date: 2018
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