Tails, Fears and Risk Premia
49 Pages Posted: 14 Apr 2010 Last revised: 26 Jan 2011
Date Written: March 5, 2010
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.
Keywords: rare events, jumps, high-frequency data, options, fears, extreme value
JEL Classification: C13, C14, G10, G12
Suggested Citation: Suggested Citation