The Term Structures of Expected Loss and Gain Uncertainty

76 Pages Posted: 30 Aug 2019 Last revised: 24 Mar 2020

See all articles by Bruno Feunou

Bruno Feunou

Bank of Canada

Ricardo Lopez Aliouchkin

Syracuse University - Whitman School of Management

Roméo Tédongap

ESSEC Business School

Lai Xu

Syracuse University

Date Written: March 23, 2020

Abstract

We document that the term structures of risk-neutral expected loss and gain uncertainty on the S&P500 returns are upward sloping on average. These shapes mainly reflect the higher premium required by investors to hedge downside risk, and the belief that potential gains will increase in the long-run. The term structures exhibit substantial time series variation with large negative slopes during crisis periods. Through the lens of Andersen et al. (2015)'s framework, we evaluate the ability of existing reduced-form option pricing models to replicate these term structures. We stress that three ingredients are particularly important: (1) the inclusion of jumps; (2) disentangling the price of negative jump risk from its positive analog in the stochastic discount factor speci fication; (3) specifying three latent factors.

Keywords: Quadratic payoff, quadratic loss, quadratic gain, quadratic risk premium, options

JEL Classification: G12

Suggested Citation

Feunou, Bruno and Lopez Aliouchkin, Ricardo and Tédongap, Roméo and Xu, Lai, The Term Structures of Expected Loss and Gain Uncertainty (March 23, 2020). Available at SSRN: https://ssrn.com/abstract=3442958 or http://dx.doi.org/10.2139/ssrn.3442958

Bruno Feunou (Contact Author)

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada
613-782-8302 (Phone)

HOME PAGE: http://kamkui.net/

Ricardo Lopez Aliouchkin

Syracuse University - Whitman School of Management ( email )

721 University Ave
Syracuse, NY NY 13244
United States
+13154433672 (Phone)

HOME PAGE: http://www.ricardolopezaliouchkin.com/

Roméo Tédongap

ESSEC Business School ( email )

Avenue Bernard Hirsch
BP 105 Cergy Cedex, 95021
France
+33134439734 (Phone)
+33134439734 (Fax)

Lai Xu

Syracuse University ( email )

900 S. Crouse Avenue
Syracuse, NY 13244-2130
United States

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