Recovering Risk Aversion from Option Prices and Realized Returns

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JACKWERTH, Jens Carsten, 2000. Recovering Risk Aversion from Option Prices and Realized Returns. In: Review of Financial Studies. 13(2), pp. 433-451

@article{Jackwerth2000Recov-11806, title={Recovering Risk Aversion from Option Prices and Realized Returns}, year={2000}, number={2}, volume={13}, journal={Review of Financial Studies}, pages={433--451}, author={Jackwerth, Jens Carsten} }

eng application/pdf terms-of-use 2000 First publ. in: Review of Financial Studies 13 (2000), 2, pp. 433-451 2011-03-25T09:40:23Z Jackwerth, Jens Carsten 2011-03-25T09:40:23Z Recovering Risk Aversion from Option Prices and Realized Returns Jackwerth, Jens Carsten A relationship exists between aggregate risk-neutral and subjective probaility distributions and risk aversion functions. We empirically derive risk aversion functions implied by option prices and realized returns on the S&P 500 index simultaneously. These risk aversion functions dramatically change shapes around the 1987 crash: Precrash, they are positive and decreasing in wealth and largely consistent with standard assumptions made in economic theory. Postcrash, they are partially negative and partially increasing and irreconcilable with those assumptions. Mispricing in the option market is the most likely cause. Simulated trading strategies exploiting the mispricing show excess returns, even after accounting for the possibility of further crashes, transaction costs, and hedges against the downside risk.

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