The Finance Brown Bag Seminar is held by the Institute for Finance, Banking and Insurance (WU Vienna) and the Vienna Graduate School of Finance (VGSF). It serves as a presentation platform for PhD students, faculty members, and visitors. An overview of BBS on the website of the Institute for Finance, Banking and Insurance.
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Fabio Girardi, WU Vienna
Risk Prudence Premia
We show that risk prudence—the aversion to downside risk—is the common source of three features of asset markets: a negative variance risk premium, a downward-sloping implied-volatility skew, and a downside-risk premium in the cross-section of stock returns. Embedding the skew-normal distribution in a minimum-divergence stochastic discount factor, we derive the prudence premia in closed form; a single parameter that aggregates the skewness of the priced factors signs them. In a Gaussian economy the variance premium vanishes for any degree of risk aversion. Estimating the discount factor from U.S. characteristic-managed portfolios—using no option data—we decompose it into a symmetric Gaussian factor and an asymmetric downside-risk factor, and reproduce the salient features of equity-index option markets: option-implied variance exceeds its realized counterpart, and out-of-the-money puts trade at higher implied volatilities than out-of-the-money calls.
