Divergence and the Price of Uncertainty

Paul Schneider and Fabio Trojani

Journal of Financial Econometrics, 2019, vol. 17, issue 3, 341-396

Abstract: Realized divergence measures the distinct realized moments associated with time-varying uncertainty. It is tradeable with divergence swaps engineered from delta-hedged option portfolios. Implied divergence decomposes the price of uncertainty into distinct implied moments, in a way that is consistent with established notions of a deviation from put-call symmetry in option markets. Empirically, market implied divergence and divergence risk premia vary substantially, in the time series, cross-sectionally and as a function of the investment horizon. Such variations can help to make the potential shortcomings of a model more directly visible.

Keywords: Bregman divergence; higher-order uncertainty; model-free trading of realized risk; divergence surface; stochastic volatility models (search for similar items in EconPapers)
JEL-codes: C14 G00 G11 G13 (search for similar items in EconPapers)
Date: 2019
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Journal of Financial Econometrics is currently edited by Allan Timmermann and Fabio Trojani

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