Market Prices of Orthogonal Risk and Risk Aversion in Complete Stochastic Volatility Models: Theoretical and Empirical

Considering a production economy with an arbitrary von-Neumann Morgenstern utility, this paper derives a general equilibrium relationship between the market prices of risks and market risk aversion under a continuous time stochastic volatility model completed by liquidly traded options. Empirical market price of orthogonal risk and risk aversion surfaces as well as their time series are obtained from traded option prices. It is found that implied risk aversion exhibits a smiling pattern across strikes and highly correlates with regular macrofinance variables.