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The cumulant risk premium

Author

Listed:
  • Albert S. (Pete)
  • Karamfil Todorov

Abstract

We develop a novel methodology to measure the risk premium of higher-order cumulants (closely related to the moments of a distribution) based on leveraged ETFs. We show that the risk premium on these ETFs reflects the difference between physical and risk-neutral cumulants, which we call the cumulant risk premium (CRP). We show that the CRP is different from zero across asset classes (equities, bonds, commodities, currencies, and volatility) and is large in times of stress. We illustrate that highly leveraged strategies are extremely exposed to higher-order cumulants. Our results have implications for hedge funds, factor models, momentum strategies, and options.

Suggested Citation

  • Albert S. (Pete) & Karamfil Todorov, 2023. "The cumulant risk premium," BIS Working Papers 1128, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:1128
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    More about this item

    Keywords

    cumulants; leverage; ETF; factor models; VIX; momentum; options;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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