Option-Implied Dependence and Correlation Risk Premium

49 Pages Posted: 19 Jun 2020 Last revised: 1 Jul 2021

See all articles by Oleg Bondarenko

Oleg Bondarenko

University of Illinois at Chicago - Department of Finance

Carole Bernard

Grenoble Ecole de Management; Vrije Universiteit Brussel (VUB)

Date Written: February 1, 2021

Abstract

We propose a novel model-free approach to obtain the joint risk-neutral distribution among several assets that is consistent with options on these assets and their weighted index. We implement this approach for the nine industry sectors comprising the S&P 500 index and find that their option-implied dependence is highly asymmetric and time-varying. We then study two conditional correlations: when the market moves down or up. The risk premium is strongly negative for the down correlation but positive for the up correlation. Intuitively, investors dislike the loss of diversification when markets fall, but they actually prefer high correlation when markets rally.

Keywords: Model-Free Dependence, Implied Correlations, Forward-Looking Dependence, Down and up Correlation, Correlation Risk Premium

JEL Classification: G11, G12, G13, G17

Suggested Citation

Bondarenko, Oleg and Bernard, Carole, Option-Implied Dependence and Correlation Risk Premium (February 1, 2021). Available at SSRN: https://ssrn.com/abstract=3618705 or http://dx.doi.org/10.2139/ssrn.3618705

Oleg Bondarenko (Contact Author)

University of Illinois at Chicago - Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States
(312) 996-2362 (Phone)
(312) 413-7948 (Fax)

Carole Bernard

Grenoble Ecole de Management ( email )

12, rue Pierre Sémard
Grenoble Cedex, 38003
France

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

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