The Department of Finance and Risk Engineering welcomes Conall O'Sullivan, Assistant Professor in Finance at the UCD Michael Smurfit Graduate Business School, and NYU FRE collaborator to the BQE Lecture Series.
Option-Implied Quantiles and Market Returns
Disaster risk embedded in short-term option contracts is reflected in the long-term equity risk premium (ERP). A novel formula is proposed to identify risk-neutral return quantiles from European option prices in a model-free manner. We use this formula to extract risk-neutral return quantiles on the S&P 500 index from January 1996 to June 2019. In univariate predictive regressions, we find the difference between 5% and 95% risk-neutral quantiles, which we call the tail difference (TD), significantly predicts equity risk premiums at horizons of more than one year based on a variety of standard error estimates. In bivariate predictive regressions, TD is found to be complementary to the variance risk premium (VRP) of Bollerslev, Tauchen and Zhou (2009) and Carr and Wu (2009), which is a significant predictor of the ERP at shorter horizons. The stochastic disaster risk consumption-based asset pricing model of Wachter (2013) is used to motivate our empirical findings.
Conall O’Sullivan graduated with a double major in Mathematics and Physics from University College Dublin (UCD) and subsequently obtained a PhD in Finance from the UCD Michael Smurfit Graduate Business School. After a spell in the asset management industry working in quantitative strategy, Conall became an Assistant Professor in Finance at the UCD Michael Smurfit Graduate Business School. His primary research interests are in derivatives and fixed income markets. Recent research has been published in the Journal of Banking and Finance, Quantitative Finance, the International Journal of Theoretical & Applied Finance, and the Journal of Computational Finance. Conall was a visiting scholar at New York University's Finance and Risk Engineering department in 2019 and is an instructor on their MSc in Financial Engineering boot camp.