Disasters Implied by Equity Index Options

We use equity index options to quantify the distribution of consumption growth disasters. The challenge lies in connecting the risk-neutral distribution of equity returns implied by options to the true distribution of consumption growth. First, we compare pricing kernels constructed from macro-finance and option-pricing models. Second, we compare option prices derived from a macro-finance model to those we observe. Third, we compare the distribution of consumption growth derived from option prices using a macro-finance model to estimates based on macroeconomic data. All three perspectives suggest that options imply smaller probabilities of extreme outcomes than have been estimated from macroeconomic data.