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Isolating the disaster risk premium with equity options |
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| Affiliation: | 1. INFN Sezione di Ferrara, Via Saragat 1, Ferrara, 44121, Italy;2. ETH Zurich, Institute for Particle Physics, Otto-Stern-Weg 5, Zurich, 8093, Switzerland;1. Universität Siegen, Department Physik, Siegen, Germany;2. Laboratoire de Physique Nucléaire et de Hautes Energies (LPNHE), Universités Paris 6 et Paris 7, CNRS-IN2P3, Paris, France;3. Instituto de Tecnologías en Detección y Astropartículas (CNEA, CONICET, UNSAM), Buenos Aires, Argentina |
| Abstract: | The US equity risk premium is approximated with a mean unhedged equity return. I utilize out-of-the-money put options to obtain a hedged equity return, which allows me to quantify the disaster risk premium as the difference between the means of unhedged and hedged equity returns. I demonstrate that a substantial fraction of the U.S. equity risk premium over the period from 1996 to 2016 is attributed to disasters defined as stock price depreciations below a pre-specified strike price. Employing alternative hedging schemes increases the contribution of disasters to the equity risk premium. |
| Keywords: | Disasters Equity risk premium Jumps Options |
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