Lévy Jump Risk: Evidence from Options and Returns

49 Pages Posted: 13 Sep 2008 Last revised: 10 Aug 2013

See all articles by Chayawat Ornthanalai

Chayawat Ornthanalai

University of Toronto - Rotman School of Management

Date Written: August 1, 2013

Abstract

Using index options and returns from 1996 to 2009, we estimate discrete-time models where asset returns follow a Brownian increment and a Lévy jump. Time variations in these models are generated with an affine GARCH, which greatly facilitates the empirical implementation. We find that the risk premium implied by infinite-activity jumps contribute to more than half of the total equity premium and dominates that of the Brownian increments suggesting that it is more representative of the risks present in the economy. Overall, our findings suggest that infinite-activity jumps, instead of the Brownian increments, should be the default modeling choice in asset pricing models.

Keywords: Levy process, risk premium, GARCH, option valuation, filtering

JEL Classification: G10, G12, G13

Suggested Citation

Ornthanalai, Chayawat, Lévy Jump Risk: Evidence from Options and Returns (August 1, 2013). EFA 2009 Bergen Meetings, Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=1267432 or http://dx.doi.org/10.2139/ssrn.1267432

Chayawat Ornthanalai (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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