The Zero-Theta Hedge Contract

We examine long-dated asset valuation under systematic and idiosyncratic risk, driven by extreme trajectories. By introducing the zero-Theta hedge contract, a negative-Delta derivative security with a maturity-independent price, we study investor attitudes toward systematic long-run crashes. Declining expected payoff with maturity signal strong crash aversion. The contract aids in decomposing the stochastic discount factor, shedding light on long-run crash risk premia. Even for volatile assets whose price comes from idiosyncratic rallies, systematic long-run crashes remain central to long-run risk valuation.
Based on a joint work with Anna Battauz and Marzia De Donno.