Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/122074 
Year of Publication: 
2015
Series/Report no.: 
Working Paper No. 741
Publisher: 
Queen Mary University of London, School of Economics and Finance, London
Abstract: 
We propose a new predictor of real economic activity (REA), namely the representative investor's implied relative risk aversion (IRRA) extracted from S&P 500 option prices. IRRA exploits the forward-looking information in option prices. It increases as risk averse investors enter the market, leading to a decrease in market risk premium thus predicting a REA improvement. In line with our hypothesis, IRRA predicts U.S. REA even when we control for well-known REA predictors. Results hold over both short and long horizons and regardless of the way we conduct inference. Moreover, IRRA forecasts REA out-of-sample over the 2008-2009 great economic recession peak.
Subjects: 
Option prices
Risk aversion
Risk-neutral moments
Real Economic Activity
JEL: 
E44
G13
G17
Document Type: 
Working Paper

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