Option‐Implied Risk Aversion Estimates

TLDR

The study uses a utility function to adjust the risk‑neutral PDF in option cross sections to derive measures of risk aversion implied by option prices. It estimates the representative agent’s relative risk aversion using FTSE 100 and S&P 500 options with power and exponential‑utility functions across multiple horizons. The resulting RRA estimates are reasonable, consistent across utility functions and markets, decline with longer horizons, and are lower during high‑volatility periods.

Abstract

ABSTRACT Using a utility function to adjust the risk‐neutral PDF embedded in cross sections of options, we obtain measures of the risk aversion implied in option prices. Using FTSE 100 and S&P 500 options, and both power and exponential‐utility functions, we estimate the representative agent's relative risk aversion (RRA) at different horizons. The estimated coefficients of RRA are all reasonable. The RRA estimates are remarkably consistent across utility functions and across markets for given horizons. The degree of RRA declines broadly with the forecast horizon and is lower during periods of high market volatility.