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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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Author Info
Pedro Santa-Clara
Shu Yan

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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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10912.

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Date of creation: Nov 2004
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Handle: RePEc:nbr:nberwo:10912

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G1 - Financial Economics - - General Financial Markets

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ángel León & Juan Nave & Gonzalo Rubio, 2005. "The Relationship between Risk and Expected Return in Europe," DFAEII Working Papers 200508, University of the Basque Country - Department of Foundations of Economic Analysis II, revised 04 Jul 2006. [Downloadable!]
  2. Constantinides, George M. & Jackwerth, Jens Carsten & Perrakis, Stylianos, 2007. "Option Pricing: Real and Risk-Neutral Distributions," MPRA Paper 11637, University Library of Munich, Germany. [Downloadable!]
    Other versions:
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