Investor Risk Aversion, News, and Implied Volatility
Summary
The document separates investor risk aversion from movements in implied volatility. It describes risk aversion as a relatively persistent feature shaped by an investor’s circumstances, while option prices can change when many market participants revise their views of an underlying asset at once. Earnings announcements, macroeconomic releases, and company news are given as examples of events that can prompt such repricing. A separate answer points to adverse-selection risk as a reason option prices may rise.
The discussion also explains that uncertainty around an event can increase option value because options have asymmetric payoffs and benefit from greater volatility. That means a rise in implied volatility does not by itself prove that investors have become more risk averse. The document offers qualitative explanations rather than data, a pricing model, or a method for forecasting event-related volatility. It also does not distinguish expected event variance from changes in volatility risk premia, so the examples should be treated as framing rather than a complete account of option prices.
Key ideas
- Investor risk aversion can reflect personal circumstances and may change more slowly than market prices.
- News can cause many investors to reprice an underlying asset and its options at the same time.
- Earnings and macroeconomic announcements are examples of events associated with higher option prices.
- Greater expected volatility can raise option value because option payoffs are asymmetric.
- A rise in implied volatility does not, on its own, establish that risk aversion has increased.
Tags
Full text
# What makes investors risk averse? # What makes investors risk averse? There are some regularly-occuring events that coincide with a rise in the implied volatility of an asset. For example, in advance of an firm's annual earnings report, it is typically expensive to buy a put option on the stock. What are some other examples of regularly occuring phenomena that tend to raise the implied vol. of an asset? ## Answer by Svisstack (score 1) https://quant.stackexchange.com/a/14542 What makes investors risk averse? Possibility of Loss. What are some other examples of regularly occuring phenomena that tend to raise the implied vol. of an asset? Everything that involves possibility of adverse-selection. ## Answer by GNUser (score 0) https://quant.stackexchange.com/a/14545 "What makes an investor risk averse?" and "What phenomena tend to raise implied vols?" are two different questions. Typically a particular investor's level of risk aversion will vary at a much slower rate, based on their particular life circumstances. For example, their net worth, target net worth, living expenses, comfort with volatility, etc. Theoretically, at this instant, you have a particular level of risk aversion. So, that level of risk aversion could cause you to bid up or down the price of an option based on your perspective of the risk inherit in a particular underlying asset at that time. Probably most of the time, you would believe some price is near an equilibrium, or within some tolerable level of that price, such that you would not engage in trading. Realistically, it would require a collection of investors bidding up/down the price of options to see significant price movements which affect the implied volatility you're talking about. And basically what kind of events will cause a collection of investors to change their perspective of an underlying asset simultaneously? News is the most likely candidate to reach a large number of people at the same time. Could be any variety of news, earnings (as you mention), macroeconomic news, press releases about a firm, etc. ## Answer by emcor (score 0) https://quant.stackexchange.com/a/14873 The fact that Implied Vol rises has absolutely nothing to do with riskaversion. If market expects volatility before an upcoming uncertain earnings report, put option prices rise naturally. This is due to the asymmetric payoff profile of options, which always gain from volatility because the downside losses are capped but upside potentially unlimited.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.