A New Predictor of U.S. Real Economic Activity: The S&P 500 Option Implied Risk Aversion

Renato Faccini, Eirini Konstantinidi (), George Skiadopoulos and Sylvia Sarantopoulou-Chiourea
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Eirini Konstantinidi: Alliance Manchester Business School, University of Manchester, Manchester M13 9PL, United Kingdom
Sylvia Sarantopoulou-Chiourea: Independent Authority for Public Revenue, 10184 Athens, Greece

Management Science, 2019, vol. 65, issue 10, 4927-4949

Abstract: We propose a new predictor of U.S. real economic activity (REA)—namely, the representative investor’s implied relative risk aversion (IRRA) extracted from S&P 500 option prices. IRRA is forward-looking and hence is expected to be related to future economic conditions. We document that U.S. IRRA predicts U.S. REA both in- and out-of-sample once we control for well-known REA predictors and take into account their persistence. An increase (decrease) in IRRA predicts a decrease (increase) in REA. We extend the empirical analysis by extracting IRRA from the South Korean, UK, Japanese, and German index option markets. We find that South Korea IRRA predicts the South Korea REA both in- and out-of-sample, as expected given the high liquidity of its index option market. We show that a parsimonious yet flexible production economy model calibrated to the U.S. economy can explain the documented negative relation between risk aversion and future economic growth.

Keywords: option prices; risk aversion; real economic activity; prediction; production economy model (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (9)

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Working Paper: A New Predictor of US. Real Economic Activity: The S&P 500 Option Implied Risk Aversion (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:65:y:2019:i:10:p:4927-4949

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