Implied Risk Aversion Smile

65 Pages Posted: 4 Mar 2020 Last revised: 15 Jun 2021

See all articles by Antoine Didisheim

Antoine Didisheim

Swiss Finance Institute, UNIL

Dimitris Karyampas

Bocconi University

Simon Scheidegger

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne)

Date Written: February 7, 2020

Abstract

How does the market makers' aversion to unhedgeable risks influence option prices? We answer this question by introducing a structural approach: deep replication. With it, we extract the risk aversion of a representative market maker for S&P500 options per contract and per day. Cross-sectionally, we show the existence of a risk aversion smile across the options' moneyness. Across time, we measure a regime change following 2008, with put options exhibiting a higher average risk aversion premium in the post-crisis environment. With a stylized model and empirical analysis, we demonstrate a link between the risk aversion smile, inventory, and unhedgeable risks.

Keywords: Deep Learning, Agent Preferences, Risk Aversion, Volatility Smile, Asset Pricing

JEL Classification: C61, C73, D82, D86, E61

Suggested Citation

Didisheim, Antoine and Karyampas, Dimitris and Scheidegger, Simon, Implied Risk Aversion Smile (February 7, 2020). Available at SSRN: https://ssrn.com/abstract=3533089 or http://dx.doi.org/10.2139/ssrn.3533089

Antoine Didisheim

Swiss Finance Institute, UNIL ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland
0797605012 (Phone)

Dimitris Karyampas

Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

Simon Scheidegger (Contact Author)

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne) ( email )

Unil Dorigny, Batiment Internef
Lausanne, 1015
Switzerland

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