BFS 2002 

Contributed Talk 
Robert Bliss, Nikolaos Panigirtzoglou
Crosssections of option prices embed the riskneutral probability densities functions (PDFs) for the future values of the underlying asset. Theory suggests that riskneutral PDFs differ from market expectations due to risk premia. Using a utility function to adjust the riskneutral PDF to produce subjective PDFs, we can obtain measures of the risk aversion implied in option prices. Using FTSE 100 and S&P 500 options, and both power and exponential utility functions, we show that subjective PDFs accurately forecast the distribution of realizations, while riskneutral PDFs do not. The estimated coefficients of relative risk aversion are all reasonable. The relative risk aversion estimates are remarkably consistent across utility functions and across markets for given horizons. The degree of relative risk aversion declines with the forecast horizon and is lower during periods of high market volatility.