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Jump and Volatility Risk and Risk Premia: A New Model and Lessons from S&P 500 Options

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  • Santa-Clara, Pedro
  • Yan, Shu
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Abstract

We use a novel pricing model to filter times series of diffusive volatility and jump intensity from S&P 500 index options. These two measures capture the ex-ante risk assessed by investors. We find that both components of risk vary substantially over time, are quite persistent, and correlate with each other and with the stock index. Using a simple general equilibrium model with a representative investor, we translate the filtered measures of ex-ante risk into an ex-ante risk premium. We find that the average premium that compensates the investor for the risks implicit in option prices, 10.1 percent, is about twice the premium required to compensate the same investor for the realized volatility, 5.8 percent. Moreover, the ex-ante equity premium that we uncover is highly volatile, with values between 2 and 32 percent. The component of the premium that corresponds to the jump risk varies between 0 and 12 percent.

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Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt5dv8v999.

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Date of creation: 09 Sep 2004
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Handle: RePEc:cdl:anderf:qt5dv8v999

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Citations

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Cited by:
  1. Santa-Clara, Pedro & Saretto, Alessio, 2004. "Option Strategies: Good Deals and Margin Calls," University of California at Los Angeles, Anderson Graduate School of Management qt0499w44p, Anderson Graduate School of Management, UCLA.
  2. Nave, Juan & Rubio Irigoyen, Gonzalo & León, Angel, 2005. "The Relationship between Risk and Expected Return in Europe," DFAEII Working Papers 2005-08, University of the Basque Country - Department of Foundations of Economic Analysis II.
  3. Constantinides, George M. & Jackwerth, Jens Carsten & Perrakis, Stylianos, 2007. "Option Pricing: Real and Risk-Neutral Distributions," MPRA Paper 11637, University Library of Munich, Germany.
  4. repec:wyi:wpaper:001983 is not listed on IDEAS
  5. Brennan, Michael J & LIU, XIAOQUAN & Xia, Yihong, 2005. "Option Pricing Kernels and the ICAPM," University of California at Los Angeles, Anderson Graduate School of Management qt4d90p8ss, Anderson Graduate School of Management, UCLA.

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