Department of Financial Engineering and Actuarial Mathematics, Soochow University; Department of Financial Engineering and Actuarial Mathematics, Soochow University
The Chinese University of Hong Kong (CUHK) - CUHK Business School; National Taiwan University - Department of Finance; National Taiwan University - Center for Research in Econometric Theory and Applications
Date Written: March 14, 2019
Abstract
We study jump variance risk by jointly examining both stock and option markets. We develop a GARCH option pricing model with jump variance dynamics and a non-monotonic pricing kernel featuring jump variance risk premium. The model yields a closed-form option pricing formula and improves in fitting index options from 1996 to 2015. The model-implied jump variance risk premium has predictive power for future market returns. In the cross-section, heterogeneity in exposures to jump variance risk leads to a 6% difference in risk-adjusted returns annually.
Chang, Hsuan-Ling and Chang, Yen-Cheng and Cheng, Hung-Wen and Cheng, Hung-Wen and Peng, Po-Hsiang and Tseng, Kevin, Jump Variance Risk: Evidence from Option Valuation and Stock Returns (March 14, 2019). Journal of Futures Markets, Volume 39, Issue 7, pp. 890-915, Available at SSRN: https://ssrn.com/abstract=2934077 or http://dx.doi.org/10.2139/ssrn.2934077
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