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A Robust Equilibrium Relationship between Market Prices of Risks and Risk Aversion in Dynamically Complete Stochastic

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  • Qian Han
  • Calum G. Turvey

Abstract

We derive a general equilibrium linear relationship between the market prices of risks and market risk aversion under a continuous time stochastic volatility model completed by liquidly traded options. The relation is robust as it is valid for both endowment and production economies, and for both regular time-separable von-Neumann Morgenstern and non-time-separable habit formation preferences. The relation can be used in practice to construct a daily market risk aversion index from options market.

Suggested Citation

  • Qian Han & Calum G. Turvey, 2013. "A Robust Equilibrium Relationship between Market Prices of Risks and Risk Aversion in Dynamically Complete Stochastic," Working Papers 2013-10-14, Wang Yanan Institute for Studies in Economics (WISE), Xiamen University.
    • Handle: RePEc:wyi:wpaper:002038
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    References listed on IDEAS

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    More about this item

    Keywords

    General equilibrium; market price of risk; market risk aversion; market pricing kernel; habit formation; stochastic volatility model;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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