Option-Implied Equity Premium Predictions via Entropic TiltinG

Davide Pettenuzzo (), Konstantinos Metaxoglou () and Aaron Smith ()
Additional contact information
Konstantinos Metaxoglou: Carleton University
Aaron Smith: University of California, Davis

No 99R, Working Papers from Brandeis University, Department of Economics and International Business School

Abstract: We propose a new method to improve density forecasts of the equity premium us- ing information from options markets. We obtain predictive densities from a stae-of-the-art stochastic volatility (SV) model, which we then tilt towards the second moment of the risk-neutral distribution implied by options prices, while imposing a non-negativity constraint on the equity premium. By combining the backward-looking information contained in the SV model with the forward-looking information from options prices, our procedure delivers sharper predictive densities. Using density forecasts of the U.S. equity premium from January 1990 to December 2014, we find that tilting leads to more accurate predictions, both in terms of statistical and economic criteria.

Keywords: entropic tilting; density forecasts; variance risk premium; equity premium; options. (search for similar items in EconPapers)
JEL-codes: C11 C22 G11 G12 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2016-01, Revised 2016-08
New Economics Papers: this item is included in nep-for and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP99R.pdf (application/pdf)

Related works:
Journal Article: Option-Implied Equity Premium Predictions via Entropic Tilting (2019)
Working Paper: Option-Implied Equity Premium Predictions via Entropic TiltinG (2016)
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