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http://ssrn.com/abstract=642305
 
 

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The World Price of Jump and Volatility Risk


Joost Driessen


Tilburg University - Department of Finance; CentER Tilburg University

Pascal J. Maenhout


INSEAD - Finance

February 2006

AFA 2005 Philadelphia Meetings, Forthcoming

Abstract:     
Jump and volatility risk are important for understanding equity returns, option pricing and asset allocation. This paper is the first to study international integration of markets for jump and volatility risk, using data on index options for each of the three main global markets: US S&P 500 index options), Europe (FTSE index options) and Asia (Nikkei index options). To explain the cross-section of expected returns on these options across strikes and maturities, we focus on return-based multi-factor models, using returns on straddles and out-of-the-money put options as proxies for volatility and jump risk factors. For each market separately, we provide evidence that volatility and jump risk are priced risk factors. There is little evidence, however, of global unconditional pricing of jump and volatility risk. We then investigate the presence of time-variation in the cross-market relationships and find evidence that UK and US option markets have become increasingly interrelated. Incorporating these time-varying patterns in conditional factor pricing models improves their fit substantially and generates some evidence of international pricing. Finally, we show that the benefits of diversifying jump and volatility risk internationally are substantial, but declining over our sample, in line with the hypothesis of increased but imperfect integration of world markets for jump and volatility risk.

Number of Pages in PDF File: 53

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Date posted: January 2, 2005  

Suggested Citation

Driessen, Joost and Maenhout, Pascal J., The World Price of Jump and Volatility Risk (February 2006). AFA 2005 Philadelphia Meetings, Forthcoming. Available at SSRN: http://ssrn.com/abstract=642305 or http://dx.doi.org/10.2139/ssrn.642305

Contact Information

Joost Driessen (Contact Author)
Tilburg University - Department of Finance ( email )
P.O. Box 90153
Tilburg, 5000 LE
Netherlands
CentER Tilburg University ( email )
P.O. Box 90153
Tilburg, 5000 LE
Netherlands
Pascal J. Maenhout
INSEAD - Finance ( email )
Boulevard de Constance
F-77305 Fontainebleau Cedex
France
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