Rare Events and Investor Risk Aversion: Evidence from Crude Oil Options

Abstract

The effect of four distinct market events on investor risk aversion is evaluated using options data on the WTI crude oil futures contract during the 2007-2011 period. The risk aversion function and the stochastic discount factor (SDF) are estimated using parametric approaches before and after each event in a fifteen-day event window. Events of a more persistent, regime change type lead to flatter risk aversion functions (i.e., less decreasing in wealth) and SDFs. In contrast, events of a transitory nature lead to steeper risk aversion functions (i.e., decreasing more rapidly in wealth) and SDFs. Practical implications are drawn.