Option-Implied Downside Risk Premiums

53 Pages Posted: 10 May 2015

See all articles by Yao Li

Yao Li

Virginia Polytechnic Institute & State University - Pamplin College of Business

Tong Wang


Date Written: March 7, 2015


This article examines downside risk premiums using S&P 500 index (SPX) options. Portfolios are constructed using the index options to replicate the downside risk factors and their average excess returns provide estimates of downside risk premiums. We show that all the market risk premium comes from the downside. The mimicking portfolio returns also show that most of the downside risk premium is associated with large market-level losses that are rarely observed. In contrast, investors seem to require little excess return for bearing moderate market-level losses. Therefore, the downside risk premium is largely a tail risk premium. We compare the downside risk premiums measured from stocks and the options to examine whether the risk is priced consistently across the two markets. Our evidence raises several concerns about the downside risk premium measures from the stock market. Overall, we find no robust evidence that downside risks are priced in the stock market in the same way as in the options market.

Keywords: index options, downside beta, downside risk premium

JEL Classification: G10, G12

Suggested Citation

Li, Yao and Wang, Tong, Option-Implied Downside Risk Premiums (March 7, 2015). Available at SSRN: https://ssrn.com/abstract=2603857 or http://dx.doi.org/10.2139/ssrn.2603857

Yao Li

Virginia Polytechnic Institute & State University - Pamplin College of Business ( email )

1016 Pamplin Hall
Blacksburg, VA 24061
United States

Tong Wang (Contact Author)


307 West Brooks, Room 205A
Norman, OK 73019
United States
2132357250 (Phone)

Register to save articles to
your library


Paper statistics

Abstract Views
PlumX Metrics