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F. Brinkmann, O. Korn, “Risk-Adjusted Option-Implied Moments” (working paper series)

F. Brinkmann, O. Korn, “Risk-Adjusted Option-Implied Moments” (working paper series)

Abstract: Option-implied moments, like implied volatility, contain useful information about an underlying asset’s return distribution, but are derived under the risk-neutral probability measure. This paper shows how to convert risk-neutral moments into the corresponding physical ones. The main theoretical result expresses moments under the physical probability measure in terms of observed option prices and the preferences of a representative investor. Based on this result, we investigate several empirical questions. We show that a model of a representative investor with CRRA utility can explain the variance risk premium for the S&P500 index but fails to capture variance and skewness risk premiums simultaneously. Moreover, we present methods to estimate forward-looking market risk premiums and investors’ disappointment aversion implied in market prices.