Option-Based Estimation of the Price of Co-Skewness and Co-Kurtosis Risk

Abstract

We show that the prices of risk for factors that are nonlinear in the market return are readily obtained using index option prices. The price of co-skewness risk corresponds to the market variance risk premium, and the price of co-kurtosis risk corresponds to the market skewness risk premium. Option-based estimates of the prices of risk lead to reasonable values of the associated risk premia. An out-of-sample analysis of factor models with co-skewness and co-kurtosis risk indicates that the new estimates of the price of risk improve the models' performance compared to regression-based estimates.

Keywords: Co-skewness, co-kurtosis, risk premia, options, cross-section, out-of-sample

JEL Classification: G12, G13, G17