Option-Implied Risk Aversion Estimates: Robustness and Patterns

40 Pages Posted: 27 Feb 2002

See all articles by Robert R. Bliss

Robert R. Bliss

affiliation not provided to SSRN

Nikolaos Panigirtzoglou

Queen Mary, University of London

Date Written: March 28, 2002

Abstract

Cross-sections of option prices embed the risk-neutral probability densities functions (PDFs) for the future values of the underlying asset. Theory suggests that risk-neutral PDFs differ from market expectations due to risk premia. Using a utility function to adjust the risk-neutral PDF to produce subjective PDFs, we can obtain measures of the risk aversion implied in option prices. Using FTSE 100 and S&P 500 options, and both power and exponential utility functions, we show that subjective PDFs accurately forecast the distribution of realizations, while risk-neutral PDFs do not. The estimated coefficients of relative risk aversion are all reasonable. The relative risk aversion estimates are remarkably consistent across utility functions and across markets for given horizons. The degree of relative risk aversion declines with the forecast horizon and is lower during periods of high market volatility.

Keywords: Risk aversion, implied probability density functions

JEL Classification: G13, C12

Suggested Citation

Bliss, Robert R. and Panigirtzoglou, Nikolaos, Option-Implied Risk Aversion Estimates: Robustness and Patterns (March 28, 2002). EFA 2002 Berlin Meetings Presented Paper; EFMA 2002 London Meetings, FRB Chicago Working Paper No. 2001-15, Available at SSRN: https://ssrn.com/abstract=301334 or http://dx.doi.org/10.2139/ssrn.301334

Robert R. Bliss (Contact Author)

affiliation not provided to SSRN

Nikolaos Panigirtzoglou

Queen Mary, University of London ( email )

Mile End Road
London, London E1 4NS
United Kingdom

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