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

Author

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  • Pedro Santa-Clara
  • Shu Yan
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.

Suggested Citation

  • Pedro Santa-Clara & Shu Yan, 2004. "Jump and Volatility Risk and Risk Premia: A New Model and Lessons from S&P 500 Options," NBER Working Papers 10912, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:10912
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    References listed on IDEAS

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    Cited by:

    1. Santa-Clara, Pedro & Saretto, Alessio, 2009. "Option strategies: Good deals and margin calls," Journal of Financial Markets, Elsevier, vol. 12(3), pages 391-417, August.
    2. León, Angel & Nave, Juan & Rubio Irigoyen, Gonzalo, 2005. "The Relationship between Risk and Expected Return in Europe," DFAEII Working Papers 1988-088X, University of the Basque Country - Department of Foundations of Economic Analysis II.
    3. Boes, M.J., 2006. "Index options : Pricing, implied densities and returns," Other publications TiSEM e9ed8a9f-2472-430a-b666-9, Tilburg University, School of Economics and Management.
    4. Shuang Li & Yanli Zhou & Yonghong Wu & Xiangyu Ge, 2017. "Equilibrium approach of asset and option pricing under Lévy process and stochastic volatility," Australian Journal of Management, Australian School of Business, vol. 42(2), pages 276-295, May.
    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.
    6. Andersen, Torben G. & Bollerslev, Tim & Huang, Xin, 2011. "A reduced form framework for modeling volatility of speculative prices based on realized variation measures," Journal of Econometrics, Elsevier, vol. 160(1), pages 176-189, January.
    7. Eva Ferreira & Mónica Gago & Angel León & Gonzalo Rubio, 2005. "An empirical comparison of the performance of alternative option pricing models," Investigaciones Economicas, Fundación SEPI, vol. 29(3), pages 483-523, September.
    8. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold, 2007. "Roughing It Up: Including Jump Components in the Measurement, Modeling, and Forecasting of Return Volatility," The Review of Economics and Statistics, MIT Press, vol. 89(4), pages 701-720, November.
    9. Constantinides, George M. & Jackwerth, Jens Carsten & Perrakis, Stylianos, 2005. "Option pricing: Real and risk-neutral distributions," CoFE Discussion Papers 05/06, University of Konstanz, Center of Finance and Econometrics (CoFE).
    10. Rubio Irigoyen, Gonzalo & Ferreira García, María Eva & Gago, Mónica & León, Angel, 2002. "An empirical comparison of the performance of alternative option pricing models," DFAEII Working Papers 1988-088X, University of the Basque Country - Department of Foundations of Economic Analysis II.
    11. George M. Constantinides & Jens Carsten Jackwerth & Stylianos Perrakis, 2009. "Mispricing of S&P 500 Index Options," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1247-1277, March.
    12. Reinhold Hafner & Martin Wallmeier, 2007. "Volatility as an Asset Class: European Evidence," The European Journal of Finance, Taylor & Francis Journals, vol. 13(7), pages 621-644.
    13. Marcos Escobar-Anel & Harold A. Moreno-Franco, 2019. "Dynamic portfolio strategies under a fully correlated jump-diffusion process," Annals of Finance, Springer, vol. 15(3), pages 421-453, September.
    14. Jian Chen & Xiaoquan Liu & Chenghu Ma, 2013. "Risk-neutral and Physical Jumps in Option Pricing," WISE Working Papers 2013-10-14, Wang Yanan Institute for Studies in Economics (WISE), Xiamen University.

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