Can Unpredictable Risk Exposure Be Priced?

65 Pages Posted: 14 Feb 2018 Last revised: 30 Aug 2023

See all articles by Ricardo Barahona

Ricardo Barahona

Banco de España; Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Joost Driessen

Tilburg University - Tilburg University School of Economics and Management; Tilburg University - Center for Economic Research (CentER)

Rik Frehen

Tilburg University - Department of Finance

Date Written: October 31, 2019

Abstract

We study the link between beta predictability and the price of risk. An investor who desires exposure to a certain risk factor needs to predict what next period's beta will be. We use a simple model to show that an ambiguity averse agent's demand is lower when betas are hard to predict, leading to a reduction in risk premiums. We test the implications for downside betas and VIX betas. We find that they have economically and statistically small prices of risk once we account for the fact that an investor cannot observe ex-post realized betas when determining asset demand.

Keywords: Risk Factors, Beta, Ambiguity Aversion, Risk Hedging

JEL Classification: G11, G12

Suggested Citation

Barahona, Ricardo and Driessen, Joost and Frehen, Rik, Can Unpredictable Risk Exposure Be Priced? (October 31, 2019). Journal of Financial Economics, 139 (2021) 522-544, Available at SSRN: https://ssrn.com/abstract=3116091 or http://dx.doi.org/10.2139/ssrn.3116091

Ricardo Barahona (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

Burgemeester Oudlaan 50
Rotterdam, 3062PA
Netherlands

Joost Driessen

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Rik Frehen

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

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