Dynamic Jump Intensities and Risk Premia: Evidence from S&P500 Returns and Options
University of Toronto - Rotman School of Management; Copenhagen Business School; University of Aarhus - CREATES
University of Houston - C.T. Bauer College of Business
University of Toronto - Rotman School of Management
September 23, 2011
Journal of Financial Economics, Forthcoming.
EFA 2008 Athens Meetings Paper
AFA 2010 Atlanta Meetings Paper
We build a new class of discrete time models where the distribution of daily returns is driven by two factors: dynamic volatility and dynamic jump intensity. Each factor has its own risk premium. The likelihood function for the models is available using analytical filtering, which makes them much easier to implement than most existing models. Estimating the models on S&P500 returns, we find that they significantly outperform standard models without jumps. We find very strong empirical support for time-varying jump intensities, and thus for flexible skewness and kurtosis dynamics. Compared to the risk premium on dynamic volatility, the risk premium on the dynamic jump intensity has a much larger impact on option prices. We confirm these findings using joint estimation on returns and large option samples, which is feasible in our class of models.
Number of Pages in PDF File: 51
Keywords: compound Poisson process, option valuation, filtering, volatility jumps, jump risk premia, time-varying jump intensity, heteroskedasticity
JEL Classification: G12working papers series
Date posted: March 7, 2008 ; Last revised: January 22, 2012
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