Option-implied objective measures of market risk

Matthias Leiss and Heinrich H. Nax

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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 the long run. 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 to 2013. This exercise results in an option-implied market view of objective riskiness. The dynamics of the resulting ‘option-implied Foster-Hart bound’ are analyzed and assessed in light of well-known risk measures including value at risk, expected shortfall and risk-neutral volatility. The new measure is shown to be a significant predictor of ahead-return downturns. Furthermore, it is able to grasp more characteristics of the risk-neutral probability distributions than other measures, furthermore exhibiting predictive consistency. The robustness of the risk-neutral density estimation method is analyzed via a bootstrap.

Keywords: risk measure; risk dynamics; risk-neutral densities; vaue at risk; expected shortfall (search for similar items in EconPapers)
JEL-codes: D81 D84 G32 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2015-11-12
New Economics Papers: this item is included in nep-cfn and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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