Lévy Jump Risk: Evidence from Options and Returns
EFA 2009 Bergen Meetings
49 Pages Posted: 13 Sep 2008 Last revised: 10 Aug 2013
Date Written: August 1, 2013
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: Suggested Citation