Joint estimation of volatility risk and tail risk premia with time-varying macro-state-dependent property
- PDF / 2,043,188 Bytes
- 41 Pages / 439.37 x 666.142 pts Page_size
- 64 Downloads / 151 Views
Joint estimation of volatility risk and tail risk premia with time‑varying macro‑state‑dependent property Sonnan Chen1 · Yuchi Gu1
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract We propose a new method to jointly estimate volatility risk and two-tail risk price with state-dependent features. Rather than assuming a constant risk price, as in existing models, this new method estimates an extended pricing kernel with macro-state-dependent risk prices. In contrast to the widely accepted constant risk price assumption, we find that the prices for equity, volatility, positive jump, and negative jump risks are strongly dependent on economic conditions. The empirical evidence shows that this new estimation for the macro-state-dependent property adds new pricing information that existing constant riskprice models do not provide. The estimation of macro-state-dependent property has important economic implications for the underlying dynamics and derivative markets. Statedependent risk prices substantially improve the explanation of the dynamic link between the underlying and option markets, and are important factors in the option market. With the out-of-sample test, the new method provides a stable estimation of the risk price dynamics. Keywords Pricing kernel · Option market · Jump risk · State-dependent risk price JEL Classification C13 · C51 · G12 · G13
1 Introduction Equity markets face numerous sources of risk, such as stochastic volatility and abrupt jumps in price, which result in incomplete and nonredundant derivatives markets. In addition, the prices of options with a range of strike prices indicate market expectations for the underlying price distribution and reflect the market’s view of potential future macro states.
Electronic supplementary material The online version of this article (https://doi.org/10.1007/s1115 6-020-00925-6) contains supplementary material, which is available to authorized users. * Yuchi Gu [email protected] Sonnan Chen [email protected] 1
Shanghai Advanced Institution of Finance (SAIF), Shanghai Jiao Tong University, No. 1954 Rd. Huashan, Shanghai 200030, China
13
Vol.:(0123456789)
S. Chen, Y. Gu
Thus, option prices contain abundant information about risk and risk prices. The various risks and how they are priced are of critical concern to both researchers and practitioners. To examine the risk price dynamics, this study proposes a new methodology to jointly estimate the state-dependent market prices of equity risk, volatility risk, and two-tailed jump risk. We also explore the economic implications of these four state-dependent risk prices in financial markets. Existing arbitrage-based or equilibrium asset pricing model (e.g., Bansal and Yaron 2004; Bollerslev and Zhou 2006; Drechsler and Yaron 2011) typically assume a timeinvariant link between the risk-neutral measure (i.e., the Q-measure) in derivatives markets and the statistical measure (i.e., the P-measure) in the underlying markets, in which the two markets (or measures)
Data Loading...
