Estimating Time-Varying Risk Aversion from Option Prices and Realized Returns

32 Pages Posted: 4 Apr 2022

See all articles by Michael Hanke

Michael Hanke

University of Liechtenstein

Maria Kosolapova

Free University of Bozen-Bolzano

Alex Weissensteiner

Free University of Bolzano Bozen

Date Written: March 14, 2022

Abstract

We combine risk-neutral densities from equity index options with realized index returns to estimate the market's risk aversion. Starting from a power utility framework with constant risk aversion, we extend it by more flexible stochastic discount factors. We allow for time-varying risk aversion of the marginal investor, and we base our estimation as much as possible on forward-looking information. While the levels of the resulting estimates for risk aversion and expected returns are in line with the literature, we find the pricing kernel puzzle to be only an intermittent phenomenon, and our results point to pro-cyclical risk aversion.

Keywords: Stochastic discount factor, Pricing kernel puzzle, Time-varying risk aversion

JEL Classification: G13, D81

Suggested Citation

Hanke, Michael and Kosolapova, Maria and Weissensteiner, Alex, Estimating Time-Varying Risk Aversion from Option Prices and Realized Returns (March 14, 2022). Available at SSRN: https://ssrn.com/abstract=4057388 or http://dx.doi.org/10.2139/ssrn.4057388

Michael Hanke

University of Liechtenstein ( email )

Fuerst Franz Josef-Strasse
Vaduz, FL-9490
Liechtenstein

Maria Kosolapova

Free University of Bozen-Bolzano ( email )

Universitätsplatz 1
Bozen-Bolzano, BZ 39100
Italy

Alex Weissensteiner (Contact Author)

Free University of Bolzano Bozen ( email )

Universitätsplatz 1
Bolzano, 39100
+39 0471 013496 (Phone)

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