Option-Implied Risk Aversion Estimates
Using a utility function to adjust the risk-neutral PDF embedded in crosssections
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 at different horizons. The estimated coefficients of
relative risk aversion are all reasonable. The relative risk aversion
estimates are remarkably consistent across utility functions and across
markets for given horizons. The degree of relative risk aversion declines
broadly with the forecast horizon and is lower during periods of high
market volatility.
