A Tale of Two Option Markets: Pricing Kernels and Volatility Risk
Board of Governors of the Federal Reserve System (FRB)
University of Chicago - Booth School of Business
December 27, 2014
Fama-Miller Working Paper, Forthcoming
Chicago Booth Research Paper No. 12-10
Using prices of both S&P 500 options and recently introduced VIX options, we study asset pricing implications of volatility risk. While pointing out the joint pricing kernel is not identified nonparametrically, we propose model-free estimates of marginal pricing kernels of the market return and volatility conditional on the VIX. We find that the pricing kernel of market return exhibits a decreasing pattern given either a high or low VIX level, whereas the unconditional estimates present a U-shape. Hence, stochastic volatility is the key state variable responsible for the U-shape puzzle documented in the literature. Finally, our estimates of the volatility pricing kernel feature a U-shape, implying that investors have high marginal utility in both high and low volatility states.
Number of Pages in PDF File: 47
Keywords: Multi-Factor Volatility Model, Pricing Kernel, Variance Swaps, VIX Options
JEL Classification: G12, G13
Date posted: March 1, 2012 ; Last revised: December 29, 2014
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