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

Sylvia Sarantopoulou-Chiourea and George Skiadopoulos
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Sylvia Sarantopoulou-Chiourea: University of Piraeus
George Skiadopoulos: Queen Mary University of London and University of Piraeus

No 741, Working Papers from Queen Mary University of London, School of Economics and Finance

Abstract: We propose a new predictor of real economic activity (REA), namely the representative investor's implied relative risk aversion (IRRA) extracted from S&P 500 option prices. IRRA exploits the forward-looking information in option prices. It increases as risk averse investors enter the market, leading to a decrease in market risk premium thus predicting a REA improvement. In line with our hypothesis, IRRA predicts U.S. REA even when we control for well-known REA predictors. Results hold over both short and long horizons and regardless of the way we conduct inference. Moreover, IRRA forecasts REA out-of-sample over the 2008-2009 great economic recession peak.

Keywords: Option prices; Risk aversion; Risk-neutral moments; Real Economic Activity (search for similar items in EconPapers)
JEL-codes: E44 G13 G17 (search for similar items in EconPapers)
Date: 2015-03-30
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Persistent link: https://EconPapers.repec.org/RePEc:qmw:qmwecw:741

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