Divergence and the Price of Uncertainty

Abstract

Realized divergence gauges the distinct realized moments associated with time-varying uncertainty and is tradeable with divergence swaps engineered from delta-hedged option portfolios. Consistently with established notions of symmetry in arbitrage-free option markets, implied divergence systematically decomposes the price of uncertainty into the contributions of distinct implied moments. Empirically, implied market divergence and market divergence premia vary substantially, in the time series, in the cross-section and in dependence of the investment horizon, making the shortcomings of a model easily visible.

Keywords: divergence, risk premia, information theory, dispersion, options

JEL Classification: C02, C23, C44, C52, C61, D81, G11, G12