Market Jump Risk and the Price Structure of Individual Equity Options

WFA 2010 Victoria meetings

55 Pages Posted: 19 Jul 2009 Last revised: 1 Jun 2010

See all articles by Redouane Elkamhi

Redouane Elkamhi

University of Toronto - Rotman School of Management

Chayawat Ornthanalai

University of Toronto - Rotman School of Management

Date Written: May 15, 2010

Abstract

The role of market jump risk premium implicit in individual equity options has not been examined to date. This paper develops a new factor model for equity returns and option pricing that takes into account the market's diffusive and jump risks. We estimate the model on a large cross section of equity returns and options. We find that market jump risk embedded in equity options is about 3.18%. This magnitude is consistent with those found in index options pricing studies which suggests that the price structure of equity and index options can be explained in a unified framework. In addition, we show that the market jump and diffusive risk premia affect equity option prices differently. Firms with a larger return compensation for the market diffusive risk have a higher option-implied volatility level while firms with a larger return compensation for market jump risk have steeper option-implied volatility slope.

Keywords: market jump risk, equity option, filtering, crash risk, skewness premium

JEL Classification: G10, G12, G13

Suggested Citation

Elkamhi, Redouane and Ornthanalai, Chayawat, Market Jump Risk and the Price Structure of Individual Equity Options (May 15, 2010). WFA 2010 Victoria meetings. Available at SSRN: https://ssrn.com/abstract=1434923

Redouane Elkamhi

University of Toronto - Rotman School of Management ( email )

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

Chayawat Ornthanalai (Contact Author)

University of Toronto - Rotman School of Management ( email )

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

Register to save articles to
your library

Register

Paper statistics

Downloads
450
Abstract Views
1,890
rank
62,336
PlumX Metrics