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Pricing of Risk in Credit and Equity Index Options - A Role for Option Order Flow?

Author

Listed:
  • Collin-Dufresne, Pierre
  • Trolle, Anders

Abstract

We find consistent evidence across ratings and regions that delta-hedged credit index options have large negative Sharpe ratios and much more so than their equity index counterparts. Risk-factors extracted from equity index options have only moderate explanatory power for the time-series and cross-sectional variation in credit option returns, while a single credit-specific factor explains much of the remaining variation. We link this factor to credit option order flow in a manner that is consistent with the predictions of a demand-based option pricing model, where order-flow risk is priced in equilibrium.

Suggested Citation

  • Collin-Dufresne, Pierre & Trolle, Anders, 2024. "Pricing of Risk in Credit and Equity Index Options - A Role for Option Order Flow?," CEPR Discussion Papers 19580, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:19580
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    File URL: https://cepr.org/publications/DP19580
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    Keywords

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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