Can unpredictable risk exposure be priced?

Ricardo Barahona, Joost Driessen, Rik Frehen*

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

Abstract

We study the link between beta predictability and the price of risk. An investor who desires exposure to a certain risk factor needs to predict what next period’s beta will be. We use a simple model to show that an ambiguity averse agent’s demand is lower when betas are hard to predict, leading to a reduction in risk premiums. We test the implications for downside betas and VIX betas. We find that they have economically and statistically small prices of risk once we account for the fact that an investor cannot observe ex-post realized betas when determining asset demand.
Original languageEnglish
Pages (from-to)522-544
JournalJournal of Financial Economics
Volume139
Issue number2
DOIs
Publication statusPublished - Feb 2021

Keywords

  • risk factors
  • beta
  • ambiguity aversion
  • risk hedging

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