Volatility Uncertainty and Jumps

Abstract

This paper analyzes the joint dynamics of S&P 500 jump risk and volatility using option-implied information. We show that the uncertainty about volatility is strongly related to the evolution of priced jump risk, but the level of volatility is not. More uncertainty about future volatility asymmetrically shifts the risk-neutral return distribution, such that the price for negative price jumps increases and the price for positive price jumps decreases. We highlight the unique information in volatility uncertainty by showing that it significantly predicts realized price jumps and returns. Our results have strong implications for option pricing models as a linear link between jump risk and volatility is commonly assumed.

Keywords: Jumps, Tail Risk, Volatility, Volatility Uncertainty, Volatility-of-Volatility, Option Pricing

JEL Classification: G12, G13