Risk Premia and Lévy Jumps: Theory and Evidence

45 Pages Posted: 12 Feb 2019 Last revised: 5 Dec 2019

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: January 25, 2019

Abstract

To study jump and volatility risk premia in asset returns, we develop a novel class of time- changed Lévy models. Our models are characterized by flexible Lévy measures, and allow consistent estimation under physical and risk neutral measures. We derive the no-arbitrage conditions under which the risk premia can take general forms. To operationalize the models, we use volume based proxies for the unobservable time changes. 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 (January 25, 2019). 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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