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Model Specification and Risk Premia: Evidence from Futures Options

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Author Info
MARK BROADIE
MIKHAIL CHERNOV
MICHAEL JOHANNES

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Abstract

This paper examines model specification issues and estimates diffusive and jump risk premia using S&P futures option prices from 1987 to 2003. We first develop a time series test to detect the presence of jumps in volatility, and find strong evidence in support of their presence. Next, using the cross section of option prices, we find strong evidence for jumps in prices and modest evidence for jumps in volatility based on model fit. The evidence points toward economically and statistically significant jump risk premia, which are important for understanding option returns. Copyright 2007 by The American Finance Association.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1540-6261.2007.01241.x
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Publisher Info
Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 62 (2007)
Issue (Month): 3 (06)
Pages: 1453-1490
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Handle: RePEc:bla:jfinan:v:62:y:2007:i:3:p:1453-1490

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  1. Paola Zerilli, 2005. "Option pricing and spikes in volatility: theoretical and empirical analysis," Money Macro and Finance (MMF) Research Group Conference 2005 76, Money Macro and Finance Research Group. [Downloadable!]
  2. Peter Christoffersen & Kris Jacobs & Yintian Wang, 2004. "Option Valuation with Long-run and Short-run Volatility Components," CIRANO Working Papers 2004s-56, CIRANO. [Downloadable!]
    Other versions:
  3. Broadie, Mark & Chernov, Mikhail & Johannes, Michael, 2007. "Understanding Index Option Returns," CEPR Discussion Papers 6239, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  4. David Backus & Mikhail Chernov & Ian Martin, 2009. "Disasters implied by equity index options," NBER Working Papers 15240, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Nicolae Garleanu & Lasse Heje Pedersen & Allen M. Poteshman, 2005. "Demand-Based Option Pricing," NBER Working Papers 11843, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Ravi Bansal & Ivan Shaliastovich, 2009. "Learning and Asset-Price Jumps," NBER Working Papers 14814, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Andrea Pascucci & Paolo Foschi, 2005. "Calibration of the Hobson&Rogers model: empirical tests," Finance 0509020, EconWPA. [Downloadable!]
  8. Geert Bekaert & Marie Hoerova & Martin Scheicher, 2009. "What Do Asset Prices Have to Say About Risk Appetite and Uncertainty?," Working Paper Series 1037, European Central Bank. [Downloadable!]
  9. Fulvio Corsi & Davide Pirino & Roberto Renò, 2008. "Volatility forecasting: the jumps do matter," Department of Economics University of Siena 534, Department of Economics, University of Siena. [Downloadable!]
  10. Paola Zerilli, 2007. "Option Pricing and Spikes in Volatility: Theoretical and Empirical Analysis," Discussion Papers 07/08, Department of Economics, University of York. [Downloadable!]
  11. Pedro Santa-Clara & Shu Yan, 2004. "Jump and Volatility Risk and Risk Premia: A New Model and Lessons from S&P 500 Options," NBER Working Papers 10912, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Peter Christoffersen & Redouane Elkamhi & Bruno Feunou & Kris Jacobs, 2009. "Option Valuation with Conditional Heteroskedasticity and Non-Normality," CREATES Research Papers 2009-33, School of Economics and Management, University of Aarhus. [Downloadable!]
  13. Ravi Bansal & Ivan Shaliastovich, 2009. "Confidence Risk and Asset Prices," NBER Working Papers 14815, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Anders B. Trolle & Eduardo S. Schwartz, 2006. "Unspanned Stochastic Volatility and the Pricing of Commodity Derivatives," NBER Working Papers 12744, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  15. Peter Christoffersen & Kris Jacobs & Chayawat Ornthanalai, 2009. "Exploring Time-Varying Jump Intensities: Evidence from S&P500 Returns and Options," CIRANO Working Papers 2009s-34, CIRANO. [Downloadable!]
  16. Fulvio Corsi & Davide Pirino & Roberto Reno, 2009. "Volatility Forecasting: The Jumps Do Matter," Global COE Hi-Stat Discussion Paper Series gd08-036, Institute of Economic Research, Hitotsubashi University. [Downloadable!]
  17. Peter Christoffersen & Kris Jacobs & Karim Mimouni, 2007. "Models for S&P500 Dynamics: Evidence from Realized Volatility, Daily Returns, and Option Prices," CREATES Research Papers 2007-37, School of Economics and Management, University of Aarhus. [Downloadable!]
  18. Valentina Corradi & Norman Swanson & Walter Distaso, 2006. "Predictive Density Estimators for Daily Volatility Based on the Use of Realized Measures," Departmental Working Papers 200620, Rutgers University, Department of Economics. [Downloadable!]
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