Option-Implied Correlations, Factor Models, and Market Risk
Author | : Adrian Buss |
Publisher | : |
Total Pages | : 53 |
Release | : 2017 |
ISBN-10 | : OCLC:1305389416 |
ISBN-13 | : |
Rating | : 4/5 (16 Downloads) |
Download or read book Option-Implied Correlations, Factor Models, and Market Risk written by Adrian Buss and published by . This book was released on 2017 with total page 53 pages. Available in PDF, EPUB and Kindle. Book excerpt: Implied correlation and variance risk premium stand out in predicting market returns. However, while the predictive ability of implied correlation lasts for up to a year, the variance risk premium predicts market returns only for one quarter ahead. Contrary to the accepted view, implied correlation predicts the market return not through a diversification risk (average correlation) channel, but by predicting a concentration of market exposure, which defines the level of non-diversifiable market risk, or systematic diversification. Economy-wide implied correlation built exclusively from option prices of nine sector ETFs and the S&P500 efficiently predicts future market returns and systematic diversification risk in the form of market betas dispersion. Newly developed implied correlations for economic sectors provide industry-related information and are used to extract option-implied risk factors from sector-based covariances.