Hecht Yoel and Pomposhko Helena
Risk-Neutral Density (RND), is a function based on an assumption that the expected yield on an underlying asset is equal to that of a risk-free yield. In this study, we estimated the distribution of the underlying asset, on a daily basis, assuming an RND, as is accepted practice. However, during our estimation, we found there remained an unexplained and systematic deviation. We considered this deviation a "risk premium" and we split it into two component factors: "The price of a unit of risk" and "the quantity of risk," which we measured in terms of standard deviation.
As a result of our estimations, we found that the "risk premium" of the NIS/$ exchange rate in the period 1997-2005 was a daily average of 1.6 percent, while for the TA-25 share index this was a daily average of 5.5 percent for the same period; and that the "price of a unit of risk" for the exchange rate was similar to that of the TA-25 index, and that in the period 1997-2005, this was equal to an average daily rate of about 0.2.
Key words: RND, risk premium, expected distribution.