A New Predictor of Real Economic Activity: The S&P 500 Option Implied Risk Aversion
59 Pages
Posted: 17 May 2017
Queen Mary, University of London
University of Manchester - Manchester Business School
University of Piraeus; Queen Mary, University of London, School of Economics and Finance
University of Piraeus
Date Written: April 21, 2017
Abstract
We propose a new predictor of real economic activity (REA), namely the representative investor’s implied relative risk aversion (IRRA) extracted from S&P 500 option prices. IRRA is forward-looking and hence, it is expected to be related to future economic conditions. We document that IRRA predicts U.S. REA both in- and out-of-sample once we control for well-known REA predictors and take into account their persistence. An increase (decrease) in IRRA predicts a decrease (increase) in REA. We extend the empirical analysis by extracting IRRA from the South Korea KOSPI 200 option market and we find that it predicts the South Korea REA, too. We show that a parsimonious yet flexible production economy model calibrated to the U.S. economy can explain the documented negative relation between risk aversion and future economic growth.
Keywords: Option prices, Risk aversion, Risk-neutral moments, Real Economic Activity, Production economy model
JEL Classification: E44, G13, G17
Suggested Citation:
Suggested Citation
Faccini, Renato and Konstantinidi, Eirini and Skiadopoulos, George S. and Sarantopoulou-Chiourea, Sylvia, A New Predictor of Real Economic Activity: The S&P 500 Option Implied Risk Aversion (April 21, 2017). Available at SSRN: https://ssrn.com/abstract=2968821
