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Divergence and the Price of Uncertainty

Author

Listed:
  • Paul Schneider
  • Fabio Trojani

Abstract

Realized divergence measures the distinct realized moments associated with time-varying uncertainty. It is tradeable with divergence swaps engineered from delta-hedged option portfolios. Implied divergence decomposes the price of uncertainty into distinct implied moments, in a way that is consistent with established notions of a deviation from put-call symmetry in option markets. Empirically, market implied divergence and divergence risk premia vary substantially, in the time series, cross-sectionally and as a function of the investment horizon. Such variations can help to make the potential shortcomings of a model more directly visible.

Suggested Citation

  • Paul Schneider & Fabio Trojani, 2019. "Divergence and the Price of Uncertainty," Journal of Financial Econometrics, Oxford University Press, vol. 17(3), pages 341-396.
    • Handle: RePEc:oup:jfinec:v:17:y:2019:i:3:p:341-396.
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nby021
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    Cited by:

    1. Alexander, Carol & Rauch, Johannes, 2021. "A general property for time aggregation," European Journal of Operational Research, Elsevier, vol. 291(2), pages 536-548.

    More about this item

    Keywords

    Bregman divergence; higher-order uncertainty; model-free trading of realized risk; divergence surface; stochastic volatility models;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G00 - Financial Economics - - General - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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