Risk Premia and Lévy Jumps: Theory and Evidence

50 Pages Posted: 12 Feb 2019 Last revised: 25 Aug 2020

See all articles by Hasan Fallahgoul

Hasan Fallahgoul

Monash University

Julien Hugonnier

Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Loriano Mancini

USI Lugano - Institute of Finance; Swiss Finance Institute

Date Written: March 4, 2020

Abstract

We develop a novel class of time-changed Lévy models which are tractable and readily applicable, capture the leverage effect, and exhibit pure jump processes with finite or infinite activity. Our models feature four nested processes reflecting market, volatility and jump risks, and observation error of time changes. To operationalize the models, we use volume-based proxies of the unobservable time changes. To estimate risk premia, we derive the change of measure analytically. An extensive time series and option pricing analysis of 16 time-changed Lévy models shows that infinite activity processes carry significant jump risk premia, and largely outperform many finite activity processes.

Keywords: Lévy jumps, time changes, tempered stable law, time series, option pricing

JEL Classification: C5, G12

Suggested Citation

Fallahgoul, Hasan A and Hugonnier, Julien and Mancini, Loriano, Risk Premia and Lévy Jumps: Theory and Evidence (March 4, 2020). Swiss Finance Institute Research Paper No. 19-49, Available at SSRN: https://ssrn.com/abstract=3327137 or http://dx.doi.org/10.2139/ssrn.3327137

Hasan A Fallahgoul

Monash University ( email )

Clayton Campus
Victoria, 3800
Australia

HOME PAGE: http://www.hfallahgoul.com

Julien Hugonnier

Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL Dorigny
Extranef
Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/hugonnier

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Loriano Mancini (Contact Author)

USI Lugano - Institute of Finance ( email )

Via Giuseppe Buffi 6
6904 Lugano, CH-6904
Switzerland
+41 (0)91 912 46 47 (Fax)

HOME PAGE: http://www.people.usi.ch/mancil/

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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