Abstract
AbstractWe show that the prices of risk for factors that are nonlinear in the market return can be obtained using index option prices. The price of coskewness risk corresponds to the market variance risk premium, and the price of cokurtosis risk corresponds to the market skewness risk premium. Option-based estimates of the prices of risk lead to reasonable values of the associated risk premia. An analysis of factor models with coskewness risk indicates that the new estimates of the price of risk improve the models’ performance compared with regression-based estimates.
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