Nicola Fusari (Johns Hopkins Carey Business School)

joint with Torben G. Andersen and Viktor Todorov

We explore the pricing of tail risk as manifest in index options across international equity mar- kets. The risk premium associated with negative tail events displays persistent shifts, unrelated to volatility. This tail risk premium is a potent predictor of future equity returns, while option implied volatility only forecasts the future return variation. Hence, compensation for negative jump risk is the primary driver of the equity premium across all indices, whereas the reward for pure diffusive variance risk is largely unrelated to future equity returns. We also document pronounced commonalities, suggesting a high degree of integration among the major global equity markets.

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