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Risk Premia and Lévy Jumps: Theory and Evidence

Author

Listed:
  • Hasan Fallahgoul

    (Monash University)

  • Julien Hugonnier

    (Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute)

  • Loriano Mancini

    (USI Lugano - Institute of Finance; Swiss Finance Institute)

Abstract

To study jump and volatility risk premia in asset returns, we develop a novel class of time-changed Lévy models. The models are characterized by flexible Lévy measures, and allow consistent estimation under physical and risk neutral measures. To operationalize the models, we introduce a simple and rigorous filtering procedure to recover the unobservable time changes. An extensive time series and option pricing analysis of 16 time-changed Lévy models shows that infinite activity processes carry significant jump risk premia, and largely outperform many finite activity processes.

Suggested Citation

  • Hasan Fallahgoul & Julien Hugonnier & Loriano Mancini, 2019. "Risk Premia and Lévy Jumps: Theory and Evidence," Swiss Finance Institute Research Paper Series 19-49, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1949
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    Keywords

    Lévy jumps; time changes; tempered stable law; time series; option pricing;
    All these keywords.

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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