Market Risk Premium Expectation: Combining Option Theory with Traditional Predictors

„The market risk premium is central in finance, and has been analyzed by numerous studies in the time-series predictability literature and by growing studies in the options literature. In this paper, we provide a novel link between the two literatures. Theoretically, we derive a lower bound on the market risk premium in terms of option prices and state variables. Empirically, we show that combining information from both options and investor sentiment significantly improves the out-of-sample predictability of the market risk premium versus using either type of information alone.”

Liu, Hong and Lu, Yueliang and Xu, Weike and Zhou, Guofu, Market Risk Premium Expectation: Combining Option Theory with Traditional Predictors (December 22, 2022).

Available at SSRN: https://ssrn.com/abstract=4310213 or http://dx.doi.org/10.2139/ssrn.4310213//