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A Nonlinear Factor Analysis of S&P 500 Index Option Returns

38 Pages Posted: 4 Jul 2001  

Christopher S. Jones

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: January 2001

Abstract

This study confronts the growing evidence that multiple sources of priced risk appear necessary to explain the expected returns of equity index options. A general class of nonlinear latent factor models is estimated using a data set of over 32,000 daily return observations on S&P 500 index put options of varying maturity and moneyness. The results show that while priced factors other than the return on the underlying security contribute to these expected returns, factor-based models are insufficient to explain their magnitude. For a variety of option classes, but particularly short-term out-of-the-money puts, the magnitude of the mispricing remains large. Out-of-sample tests confirm the usefulness of the semiparametric latent factor approach in hedging a book of put options and in forming portfolios that exploit apparent option mispricing.

Suggested Citation

Jones, Christopher S., A Nonlinear Factor Analysis of S&P 500 Index Option Returns (January 2001). AFA 2002 Atlanta Meetings. Available at SSRN: https://ssrn.com/abstract=275892 or http://dx.doi.org/10.2139/ssrn.275892

Christopher Jones (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

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