Options-Pricing Formula with Disaster Risk

Barro, Robert J.; Liao, Gordon Y.

doi:10.3386/w21888

Cited by 10 publications

(15 citation statements)

References 25 publications

(44 reference statements)

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“…Our data contain the universe of put options traded on the Athens Stock Exchange between 2001 and 2017. The Barro and Liao (2016) model fits the data well, with an elasticity of the option price to moneyness similar to that found for other countries.…”

Section: Driving Forcessupporting

confidence: 68%

“…Parameters set without solving the model. Beginning in the upper panel of Table 1, the coefficient of relative risk aversion is σ = 3, consistent with the Barro and Liao (2016) choice of σ and our implementation of their methodology for recovering the time-varying disaster probability π. Using their methodology, we estimate ϕ = 0.24 so that the economy scales down by exp(−ϕ) = 0.79 conditional on a disaster.…”

Section: Parameterizationsupporting

confidence: 64%

“…22 Disaster risk. We follow Barro and Liao (2016) to recover a time series of disaster probabilities π from prices of far-out-of-the-money put options. A far-out-of-the-money put option pays off only when stock prices fall by a large amount, so the price of such an option provides information about the probability a disaster occurs (in which case the option becomes in the money), the size of a disaster conditional on one occurring, and risk aversion.…”

Section: Driving Forcesmentioning

confidence: 99%

“…A far-out-of-the-money put option pays off only when stock prices fall by a large amount, so the price of such an option provides information about the probability a disaster occurs (in which case the option becomes in the money), the size of a disaster conditional on one occurring, and risk aversion. Appendix B.6 details our implementation of the Barro and Liao (2016) procedure. Our data contain the universe of put options traded on the Athens Stock Exchange between 2001 and 2017.…”

Section: Driving Forcesmentioning

confidence: 99%

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The Macroeconomics of the Greek Depression

2019

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The Greek economy experienced a boom until 2007, followed by a prolonged depression resulting in a 25 percent shortfall of GDP by 2016. Informed by a detailed analysis of macroeconomic patterns in Greece, we estimate a rich dynamic general equilibrium model to assess quantitatively the sources of the boom and bust. Lower external demand for traded goods and contractionary fiscal policies account for the largest fraction of the Greek depression. A decline in total factor productivity, due primarily to lower factor utilization, substantially amplifies the depression. Given the significant adjustment of prices and wages observed throughout the cycle, a nominal devaluation would only have short-lived stabilizing effects. By contrast, shifting the burden of adjustment away from taxes toward spending or away from capital taxes toward other taxes would generate longer-term production and consumption gains. Eliminating the rise in transfers to households during the boom would significantly reduce the burden of tax adjustment in the bust and the magnitude of the depression.

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Section: Driving Forcessupporting

confidence: 68%

Section: Parameterizationsupporting

confidence: 64%

Section: Driving Forcesmentioning

confidence: 99%

Section: Driving Forcesmentioning

confidence: 99%

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The Macroeconomics of the Greek Depression

2019

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“…The link between option prices and tail probabilities has been studied by several authors using various different approaches. See, for example, Bates (1991), Backus, Chernov, and Zin (2011), Bollerslev and Todorov (2011), and Barro and Liao (2016).…”

Section: S T S Tmentioning

confidence: 99%

What Is the Expected Return on the Market?

Martin

2016

SSRN Journal

194

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I derive a lower bound on the equity premium in terms of a volatility index, SVIX, that can be calculated from index option prices. The bound implies that the equity premium is extremely volatile and that it rose above 20% at the height of the crisis in 2008. The time-series average of the lower bound is about 5%, suggesting that the bound may be approximately tight. I run predictive regressions and find that this hypothesis is not rejected by the data, so I use the SVIX index as a proxy for the equity premium and argue that the high equity premia available at times of stress largely reflect high expected returns over the very short run. I also provide a measure of the probability of a market crash, and introduce simple variance swaps, tradable contracts based on SVIX that are robust alternatives to variance swaps. JEL Codes: E44, G1.

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Economic disasters and aggregate investment

Ćorić

Šimić

2021

Empir Econ

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The -2008 global financial crisis has spurred an increasing interest for investigating the financial and macroeconomic effects of the rare but extremely large economic crises, the so-called economic disasters. Current literature on the topic shows that probability of economic disasters plays an important role in the long-run effect of output volatility on investment. This paper investigates the long-run relationship between economic disasters and aggregate investment. We analyze the data for a large number of developing and developed countries after the World War II. The conducted panel data analysis indicates a negative effect of the probability of economic disasters on aggregate investment. Our results contribute to the recent literature on economic disasters by providing empirical support for the hypothesis that probability of infrequent but extremely large economic crises has a negative longrun effect on investment. We also find that the effect of 'normal' output volatility on aggregate investment is relatively small.

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Options-Pricing Formula with Disaster Risk

Cited by 10 publications

References 25 publications

The Macroeconomics of the Greek Depression

The Macroeconomics of the Greek Depression

What Is the Expected Return on the Market?

Economic disasters and aggregate investment

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