Systematic Risk and Option Prices

Abstract

In a recent paper, Duan and Wei (2007) find that the higher the proportion of systematic risk the higher will be the level and the slope of the implied volatility curve. We show that this result can be explained in a variety of continuous - time option pricing models and explicitly point out the transmission mechanisms that lead to an impact of systematic risk on option prices. Most importantly we show that an investor who uses the structurally correct model but ignores the proportion of systematic risk in the underlying would still price options correctly.

Keywords: Option Valuation, Systematic Risk, Asset Pricing

JEL Classification: G12, G13