Implied risk aversion in option prices using Hermite polynomials

The aim of this paper is to construct a time-varying estimator of the investors' risk aversion function. Jackwerth (1996) and Ait-Sahalia and Lo (1998) show that there exists a theoretical relationship between the Risk Neutral Density (RND), the Subjective Density (SD), and the Risk Aversion Function. The RND is estimated from options prices and the SD is estimated from underlying asset time series. Both densities are estimated on daily French data using Hermite polynomials' expansions as suggested first by Madan and Milne (1994). We then deduce an estimator of the Risk Aversion Function and show that it is time varying.