Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/195460
Authors: 
Kotchoni, Rachidi
Year of Publication: 
2018
Citation: 
[Journal:] Econometrics [ISSN:] 2225-1146 [Volume:] 6 [Year:] 2018 [Issue:] 3 [Pages:] 1-27
Abstract: 
This paper proposes an approach to measure the extent of nonlinearity of the exposure of a financial asset to a given risk factor. The proposed measure exploits the decomposition of a conditional expectation into its linear and nonlinear components. We illustrate the method with the measurement of the degree of nonlinearity of a European style option with respect to the underlying asset. Next, we use the method to identify the empirical patterns of the return-risk trade-off on the SP500. The results are strongly supportive of a nonlinear relationship between expected return and expected volatility. The data seem to be driven by two regimes: one regime with a positive return-risk trade-off and one with a negative trade-off.
Subjects: 
conditional expectation
nonlinearity
orthogonal polynomials
return-risk trade-off
JEL: 
C10
G10
Persistent Identifier of the first edition: 
Creative Commons License: 
https://creativecommons.org/licenses/by/4.0/
Document Type: 
Article
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