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The risk premia embedded in index options

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  • Andersen, Torben G.
  • Fusari, Nicola
  • Todorov, Viktor

Abstract

We study the dynamic relation between market risks and risk premia using time series of index option surfaces. We find that priced left tail risk cannot be spanned by market volatility (and its components) and introduce a new tail factor. This tail factor has no incremental predictive power for future volatility and jump risks, beyond current and past volatility, but is critical in predicting future market equity and variance risk premia. Our findings suggest a wide wedge between the dynamics of market risks and their compensation, which typically displays a far more persistent reaction following market crises.

Suggested Citation

  • Andersen, Torben G. & Fusari, Nicola & Todorov, Viktor, 2015. "The risk premia embedded in index options," Journal of Financial Economics, Elsevier, vol. 117(3), pages 558-584.
  • Handle: RePEc:eee:jfinec:v:117:y:2015:i:3:p:558-584
    DOI: 10.1016/j.jfineco.2015.06.005
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    2. José P. Dapena & Juan A. Serur & Julián R. Siri, 2018. "Measuring and trading volatility on the US stock market: A regime switching approach," CEMA Working Papers: Serie Documentos de Trabajo. 659, Universidad del CEMA.
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    4. repec:taf:jnlasa:v:112:y:2017:i:517:p:384-396 is not listed on IDEAS
    5. Christian Gourieroux & Joann Jasiak & Peng Xu, 2016. "The Tradability Premium on the S&P 500 Index," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 14(3), pages 461-495.
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    7. George M. Constantinides & Lei Lian, 2015. "The Supply and Demand of S&P 500 Put Options," NBER Working Papers 21161, National Bureau of Economic Research, Inc.
    8. Peter Van Tassel, 2017. "Global Variance Term Premia and Intermediary Risk Appetite," 2017 Meeting Papers 149, Society for Economic Dynamics.
    9. Barletta, Andrea & Santucci de Magistris, Paolo & Violante, Francesco, 2019. "A non-structural investigation of VIX risk neutral density," Journal of Banking & Finance, Elsevier, vol. 99(C), pages 1-20.
    10. Shaliastovich, Ivan, 2015. "Learning, confidence, and option prices," Journal of Econometrics, Elsevier, vol. 187(1), pages 18-42.
    11. Schneider, Paul & Wagner, Christian & Zechner, Josef, 2016. "Low risk anomalies?," CFS Working Paper Series 550, Center for Financial Studies (CFS).
    12. Bollerslev, Tim & Todorov, Viktor & Xu, Lai, 2015. "Tail risk premia and return predictability," Journal of Financial Economics, Elsevier, vol. 118(1), pages 113-134.
    13. Filipović, Damir & Gourier, Elise & Mancini, Loriano, 2016. "Quadratic variance swap models," Journal of Financial Economics, Elsevier, vol. 119(1), pages 44-68.
    14. KALNINA, Ilze & XIU, Dacheng, 2015. "Nonparametric estimation of the leverage effect: a trade-off between robustness and efficiency," Cahiers de recherche 2015-05, Universite de Montreal, Departement de sciences economiques.
    15. Antonio Cosma & Stefano Galluccio & Paola Pederzoli & Olivier Scaillet, 2016. "Early exercise decision in American options with dividends, stochastic volatility and jumps," Papers 1612.03031, arXiv.org.
    16. repec:eee:econom:v:203:y:2018:i:2:p:297-315 is not listed on IDEAS
    17. Andrea Barletta & Paolo Santucci de Magistris & Francesco Violante, 2016. "Retrieving Risk-Neutral Densities Embedded in VIX Options: a Non-Structural Approach," CREATES Research Papers 2016-20, Department of Economics and Business Economics, Aarhus University.
    18. Van Tassel, Peter & Vogt, Erik, 2016. "Global variance term premia and intermediary risk appetite," Staff Reports 789, Federal Reserve Bank of New York.
    19. David S. Bates, 2016. "How Crashes Develop: Intradaily Volatility and Crash Evolution," NBER Working Papers 22028, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Option pricing; Risk premia; Jumps; Stochastic volatility; Return predictability; Risk aversion; Extreme events;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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