Professor Pedro Santa-Clara from UCLA is giving a seminar on "Crashes, Volatility,
and the Equity Premium: Lessons from S&P500 Options" on Friday, January 26th,
2.00-3.30 pm, at the WU Wien (Seminarraum D204, UZA 4, Nordbergstrasse 15, 1090 Wien, see
http://www.wu-wien.ac.at/portal/ueber_wu/standorte/lageplan4 for a map). Please find below
the paper's abstract.
Best regards,
Youchang Wu
Abstract:
We use a novel pricing model to imply times series of diffusive volatility and jump
intensity from S&P 500 index options. These two measures capture the ex-ante risk
assessed by investors. Ex-ante risk differs from realized risk (e.g., the volatility
measured from the time series of returns) to the extent that investors at times perceive
as probable crashes that end up not happening. We find that both components of risk vary
substantially over time, are quite persistent, and correlate with each other and with the
stock index. Using a simple general equilibrium model with a CRRA representative investor,
we translate the ex-ante risk into an ex-ante risk premium. We find that the average
premium that compensates the investor for the ex-ante risks implicit in option prices is
11.8 percent, much higher than the 7.1 percent premium required to compensate the same
investor for realized risks. Moreover, the ex-ante equity premium that we uncover is
highly volatile, with values between 0.3 and 54.9 percent. The component of the premium
that corresponds to jump risk varies between zero and 45.4 percent. Ex-ante risks implicit
in option prices justify a higher and more variable equity risk premium than the realized
risk would warrant.