Abstract
We characterize a set of risk-neutral measures associated with a comprehensive class of risk averse investors. From this set, we show how to construct option price bounds and recover the implied γ: a parameter uniquely identifying the marginal investor pricing a given option. Empirically, we find that S&P 500 option prices are reconciled by heterogeneous marginal investors who differ in their assessment of tail risk. This heterogeneity is time-varying, decreases during financial crises, and provides novel insights into the skew patterns of index options. The recovered investors’ preferences related to compensation for downside risk help predict future market returns.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 174-205 |
| Number of pages | 32 |
| Journal | Journal of Financial Economics |
| Volume | 144 |
| Issue number | 1 |
| DOIs | |
| State | Published - Apr 2022 |
All Science Journal Classification (ASJC) codes
- Accounting
- Finance
- Economics and Econometrics
- Strategy and Management
Keywords
- Incomplete markets
- Market segmentation
- Option pricing
- Return predictability
- Risk-neutral measure