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Tails, Fears, and Risk Premia

TIM BOLLERSLEV and VIKTOR TODOROV
The Journal of Finance
Vol. 66, No. 6 (DECEMBER 2011), pp. 2165-2211
Published by: Wiley for the American Finance Association
Stable URL: http://www.jstor.org/stable/41305187
Page Count: 47
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Tails, Fears, and Risk Premia
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Abstract

We show that the compensation for rare events accounts for a large fraction of the average equity and variance risk premia. Exploiting the special structure of the jump tails and the pricing thereof, we identify and estimate a new Investor Fears index. The index reveals large time-varying compensation for fears of disasters. Our empirical investigations involve new extreme value theory approximations and high-frequency intraday data for estimating the expected jump tails under the statistical probability measure, and short maturity out-of-the-money options and new model-free implied variation measures for estimating the corresponding risk-neutral expectations.

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