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Option-Implied Objective Measures of Market Risk with Leverage

  • Matthias Leiss
  • Heinrich H. NaxEmail author
Conference paper
Part of the Springer Proceedings in Mathematics & Statistics book series (PROMS, volume 214)

Abstract

Leverage has been shown to be procyclical and indicative of financial market risk. Here, we present a novel, inherently forward-looking way to estimate market leverage ratios based on derivative prices, option hedging, and the ‘operational’ riskiness measure by Foster and Hart (J Polit Econ 117(5):785–814, 2009). Furthermore, we report option-implied ‘optimal’ leverage levels inferred via the (Kelly, IRE Trans. Inf. Theory 2(3):185–189, 1956) criterion. The resulting measure of leverage exhibits strong procyclicality prior to the Global Financial Crisis of 2008. Finally, we find it to successfully predict large stock market downturns.

Keywords

Objective risk Foster-Hart Leverage Risk-neutral densities 

Notes

Acknowledgements

Leiss acknowledges support from the ETH Risk Center and through SNF grant The Anatomy of Systemic Financial Risk, Nax from the European Commission through the ERC Advanced Investigator Grant Momentum (Grant No. 324247).

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Copyright information

© Springer International Publishing AG 2017

Authors and Affiliations

  1. 1.Department of HumanitiesSocial and Political Sciences, ETH ZurichZurichSwitzerland

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