Conditional Leverage and the Term Structure of Option-Implied Equity Risk Premia

In a one-period economy, Martin (2017) and Chabi-Yo and Loudis (2020) derive bounds for the equity risk premium that use options of the same maturity as the horizon at which the premium is measured. In contrast, we provide an expression and an empirical methodology to measure the premium at a given horizon in a multi-period economy using options of multiple maturities. The premium depends on risk-neutral leverage effects and the expected future risk-neutral market variance and skewness, which contribute to increasing the premium at short horizons. Our measure outperforms in terms of prediction accuracy and portfolio allocation performance. The term structure of expected excess holding period returns is flatter on average and dramatically more negative during market turmoil than those implied by previous measures