An Approach to Measure the Expectation of Generic Functions of the Market Return

59 Pages Posted: 11 Sep 2017

See all articles by Gurdip Bakshi

Gurdip Bakshi

Fox School of Business

Xiaohui Gao Bakshi

Fox School of Business, Temple University

Jinming Xue

University of Maryland - Department of Finance

Date Written: August 24, 2017

Abstract

This paper proposes an approach that associates the risk-neutral probability measure with option prices and then computes the expectation of quantities under the real world probability measure, exploiting the form of the stochastic discount factor. This approach deviates from foundational approaches that embrace assumptions about preferences and economic primitives to propose formulas for prices and risk premiums. Our method is analytically tractable, absolved of distributional assumptions, and we use the approach to elaborate on empirical questions regarding disaster probabilities, conditional return moments, and conditional return asymmetries.

Keywords: Expected market return; Disaster probabilities; Girsanov theorem; Equity index options

Suggested Citation

Bakshi, Gurdip S. and Gao, Xiaohui and Xue, Jinming, An Approach to Measure the Expectation of Generic Functions of the Market Return (August 24, 2017). Available at SSRN: https://ssrn.com/abstract=3033834 or http://dx.doi.org/10.2139/ssrn.3033834

Gurdip S. Bakshi

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Xiaohui Gao (Contact Author)

Fox School of Business, Temple University ( email )

Philadelphia, PA 19122
United States

Jinming Xue

University of Maryland - Department of Finance ( email )

Robert H. Smith School of Business
Van Munching Hall
College Park, MD 20742
United States

HOME PAGE: http://https://sites.google.com/view/jinmingxue/home

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