Disasters implied by equity index options

David Backus, Mikhail Chernov and Ian Martin

No 7416, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We use prices of equity index options to quantify the impact of extreme events on asset returns. We define extreme events as departures from normality of the log of the pricing kernel and summarize their impact with high-order cumulants: skewness, kurtosis, and so on. We show that high-order cumulants are quantitatively important in both representative-agent models with disasters and in a statistical pricing model estimated from equity index options. Option prices thus provide independent confirmation of the impact of extreme events on asset returns, but they imply a more modest distribution of them.

Keywords: Cumulants; Entropy; Equity premium; Implied volatility; Pricing kernel; Risk-neutral probabilities (search for similar items in EconPapers)
JEL-codes: E44 G12 (search for similar items in EconPapers)
Date: 2009-08
New Economics Papers: this item is included in nep-bec, nep-fmk, nep-mac and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Related works:
Journal Article: Disasters Implied by Equity Index Options (2011)
Working Paper: Disasters implied by equity index options (2009)
Working Paper: Disasters Implied by Equity Index Options (2009)
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