Option pricing under time-varying risk-aversion with applications to risk forecasting |
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| Institution: | 1. University of Duisburg-Essen, 45117 Essen, Germany;2. Centre of Mathematics for Applications, University of Oslo, Oslo, Norway;3. Ulm University, 89081 Ulm, Germany;4. PhD Training Programme 1100, Ulm University, 89081 Ulm, Germany;1. Dipartimento di Management, Università Politecnica delle Marche, Piazzale Martelli 8, Ancona 60121, Italy;2. Dipartimento di Scienze Economiche e Sociali, Università Politecnica delle Marche, Piazzale Martelli 8, Ancona 60121, Italy |
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| Abstract: | We present a two-factor option-pricing model, which parsimoniously captures the difference in volatility persistences under the historical and risk-neutral probabilities. The model generates an S-shaped pricing kernel that exhibits time-varying risk aversion. We apply our model for two purposes. First, we analyze the risk preference implied by S&P500 index options during 2001–2009 and find that risk-aversion level strongly increases during stressed market conditions. Second, we apply our model for Value-at-Risk (VaR) forecasts during the subprime crisis period and find that it outperforms several leading VaR models. |
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