Option-implied preferences adjustments, density forecasts, and the equity risk premium

Francisco Alonso (), Roberto Blanco and Gonzalo Rubio ()
Additional contact information
Francisco Alonso: Banco de España
Gonzalo Rubio: Euskal Herriko Unibertsitatea

No 630, Working Papers from Banco de España

Abstract: The main objective of this paper is to analyse the value of information contained in prices of options on the IBEX 35 index at the Spanish Stock Exchange Market. The forward looking information is extracted using implied risk-neutral density functions estimated by a mixture of two lognormals and several alternative risk adjustments: the power, exponential and habit inspired based stochastic discount factors. Moreover, by allowing additional flexibility in the shape of the stochastic discount factor, two other ad hoc time varying risk aversion adjustments are also employed. Our results show that, between October 1996 and March 2000, we can reject the hypothesis that the risk neutral densities provide accurate predictions of the distributions of future realisations of the IBEX 35 index at four and eight week horizons. When forecasting through risk adjusted densities the performance of this period is statistically improved and we no longer reject that hypothesis. Somehow surprisingly, all risk adjusted densities generate similar forecasting statistics. Finally, from October 1996 to December 2004, the ex ante risk premium perceived by investors and that are embedded in option prices is between 12 and 18 percent higher than the premium required to compensate the same investors for the realised volatility in stock market returns.

Keywords: risk-adjustments; option-implied densities; forecasting performance; equity-risk premium (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2006-11
New Economics Papers: this item is included in nep-fmk, nep-for and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://www.bde.es/f/webbde/SES/Secciones/Publicaci ... o/06/Fic/dt0630e.pdf First version, Nobember 2006 (application/pdf)

Related works:
Journal Article: Option-implied preferences adjustments, density forecasts, and the equity risk premium (2009)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:0630

Access Statistics for this paper

More papers in Working Papers from Banco de España Contact information at EDIRC.
Bibliographic data for series maintained by Ángel Rodríguez. Electronic Dissemination of Information Unit. Research Department. Banco de España ().