On the Nature of Jump Risk Premia
71 Pages Posted: 6 Jun 2019 Last revised: 9 Jun 2019
Date Written: May 21, 2019
We shed light on the nature of jump risk compensation by studying the profits from a trading strategy that bets on the high-frequency jump skew of S&P 500 returns. Earlier evidence suggests the jump risk premium is large and positive. We find it to be concentrated in periods when the index option market is closed, and investors cannot trade options. Whenever jump skew can be traded continuously, the premium vanishes. We conclude the jump skew premium in index options is not compensation for the risk of occasional, large returns, but for the investors’ inability to adjust their nonlinear risk exposure.
Keywords: rare events, jump risk premium, options, high-frequency data
JEL Classification: G10, G12, C58
Suggested Citation: Suggested Citation