Tails, Fears and Risk Premia
Duke University - Finance; Duke University - Department of Economics; National Bureau of Economic Research (NBER)
March 5, 2010
Journal of Finance, Forthcoming
Economic Research Initiatives at Duke (ERID) Working Paper Paper No. 34
We show that the compensation for rare events accounts for a large fraction of the average equity and variance risk premia. Exploiting the special structure of the jump tails and the pricing thereof we identify and estimate a new Investor Fears index. The index suggests both large and time-varying compensations for fears of disasters. Our empirical investigations are essentially model-free, involving new extreme value theory approximations and high-frequency intraday data for estimating the expected jump tails under the statistical probability measure, and short maturity out-of-the money options and new model-free implied variation measures for estimating the corresponding risk neutral expectations.
Number of Pages in PDF File: 49
Keywords: rare events, jumps, high-frequency data, options, fears, extreme value
JEL Classification: C13, C14, G10, G12Accepted Paper Series
Date posted: April 14, 2010 ; Last revised: January 26, 2011
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