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Option-implied volatility factors and the cross-section of market risk premia

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  • Li, Junye
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    Abstract

    The main goal of this paper is to study the cross-sectional pricing of market volatility. The paper proposes that the market return, diffusion volatility, and jump volatility are fundamental factors that change the investors’ investment opportunity set. Based on estimates of diffusion and jump volatility factors using an enriched dataset including S&P 500 index returns, index options, and VIX, the paper finds negative market prices for volatility factors in the cross-section of stock returns. The findings are consistent with risk-based interpretations of value and size premia and indicate that the value effect is mainly related to the persistent diffusion volatility factor, whereas the size effect is associated with both the diffusion volatility factor and the jump volatility factor. The paper also finds that the use of market index data alone may yield counter-intuitive results.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 36 (2012)
    Issue (Month): 1 ()
    Pages: 249-260

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    Handle: RePEc:eee:jbfina:v:36:y:2012:i:1:p:249-260

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Stochastic discount factor; Volatility components; Volatility risk premia; Value and size effects; Unscented Kalman filter;

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    References

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    Cited by:
    1. Christian Gouriéroux & Joann Jasiak & Peng Xu, 2013. "Non-tradable S&P 500 Index and the Pricing of Its Traded Derivatives," Working Papers 2013-05, Centre de Recherche en Economie et Statistique.
    2. Goodell, John W. & Vähämaa, Sami, 2013. "US presidential elections and implied volatility: The role of political uncertainty," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 1108-1117.

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