Estimating Option-Implied Risk Aversion – A Case For India
Speaker(s) Ms. Sonalika Sinha, Manager, International Department, Reserve Bank of India Publication Reserve Bank of India, CAFRAL, Mezzanine floor, Main Building, Shahid Bhagat Singh road, Fort, Mumbai 400001

What do nearly 1.5 lakh observations of options data say about risk preferences of Indian investors? This paper explores a nonparametric technique to compute probability density functions (PDFs) directly from NIFTY 50 option prices in India, based on the utility preferences of the representative agent. Use of probability density functions to estimate investor expectations of the distribution of future levels of the underlying assets has gained tremendous popularity over the last decade. Studying option prices provides information about the market participants’ probability assessment of the future outcome of the underlying asset. I compare the forecast ability of the risk-neutral PDF and risk-adjusted density functions to arrive at a unique index of relative risk aversion for Indian markets. Results indicate that risk-adjusted PDFs are reasonably better forecasts of investor expectations of future levels of the underlying assets. The computed time-series of relative risk aversion overcomes the limitations of the VIX (implied volatility index) to yield a more reliable index, particularly useful for the Indian markets.