Implied risk aversion and volatility risk premiums
Since investor risk aversion determines the premium required for bearing risk, a comparison thereof provides evidence of the different structure of risk premium across markets. This article estimates and compares the degree of risk aversion of three actively traded options markets:
the S&P 500, Nikkei 225 and KOSPI 200 options markets. The estimated risk aversions is found to follow S&P 500, Nikkei 225 and KOSPI 200 options in descending order, implying that S&P 500 investors require more compensation than other investors for bearing the same risk. To prove
this empirically, we examine the effect of risk aversion on volatility risk premium, using delta-hedged gains. Since more risk-averse investors are willing to pay higher premiums for bearing volatility risk, greater risk averseness can result in a severe negative volatility risk premium, which
is usually understood as hedging demands against the underlying asset's downward movement. Our findings support the argument that S&P 500 investors with higher risk aversion pay more premiums for hedging volatility risk.
Keywords: G13; G15; KOSPI 200 index options; Nikkei 225 index options; S&P 500 index options; risk aversion; volatility risk premium
Document Type: Research Article
Affiliations: 1: Department of Finance, Hallym University, Hallymdaehak-gil 39, Chuncheon 200-702, Korea 2: Graduate School of Finance, KAIST Business School, Seoul, Korea
Publication date: 01 January 2012
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