Horizon-Dependent Risk Pricing: Evidence from Short-Dated Options

26 Pages Posted: 15 Aug 2019

See all articles by Eben Lazarus

Eben Lazarus

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: September 28, 2018

Abstract

I present evidence from index options that the price of risk over the value of the S&P 500 increases as the investment horizon becomes shorter. I show first how these risk prices may be estimated from the data, by translating the risk-neutral probabilities implied by options prices into physical probabilities that must provide unbiased forecasts of the terminal outcome. The risk price can be interpreted as the marginal investor’s effective risk aversion, and estimating this value over different option-expiration horizons for the S&P, I find that risk aversion is reliably higher for near-term outcomes than for longer-term outcomes: the market’s relative risk aversion over terminal index values decreases from around 15 at a one-week horizon to around 3 at a 12-week horizon. It is difficult to reconcile these findings with leading asset-pricing models, and I discuss necessary conditions for any such rational model to produce such a pattern. Models with dynamically inconsistent risk preferences, however, are capable of straightforwardly producing the findings presented here, and I discuss possible specifications of such models and their applicability to related results from previous literature.

Suggested Citation

Lazarus, Eben, Horizon-Dependent Risk Pricing: Evidence from Short-Dated Options (September 28, 2018). Available at SSRN: https://ssrn.com/abstract=3436389 or http://dx.doi.org/10.2139/ssrn.3436389

Eben Lazarus (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street, E62-633
Cambridge, MA 02142
United States
6173247036 (Phone)

HOME PAGE: http://elazarus.mit.edu

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
77
Abstract Views
534
rank
425,017
PlumX Metrics