Jumps and the Correlation Risk Premium: Evidence from Equity Options

58 Pages Posted: 13 Sep 2019

See all articles by Nicole Branger

Nicole Branger

University of Muenster - Finance Center Muenster

René Marian Flacke

University of Muenster - Finance Center Muenster

T. Frederik Middelhoff

University of Muenster - Finance Center Muenster

Date Written: September 5, 2019

Abstract

This paper breaks the correlation risk premium down into two components: a premium related to the correlation of continuous stock price movements and a premium for bearing the risk of co-jumps. We propose a novel way to identify both premiums based on dispersion trading strategies that go long an index option portfolio and short a basket of option portfolios on the constituents. The option portfolios are constructed to only load on either diffusive volatility or jump risk. We document that both risk premiums are economically and statistically significant for the S&P 100 index. In particular, selling insurance against co-jumps generates a sizable annualized Sharpe ratio of 0.85.

Keywords: Asset Pricing, Correlation, Financial Economics, Options, Risk Premium, Stock Market Forecasting

JEL Classification: C1, G12, G13, G17

Suggested Citation

Branger, Nicole and Flacke, René Marian and Middelhoff, Frederik T., Jumps and the Correlation Risk Premium: Evidence from Equity Options (September 5, 2019). Available at SSRN: https://ssrn.com/abstract=3448522 or http://dx.doi.org/10.2139/ssrn.3448522

Nicole Branger

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

René Marian Flacke (Contact Author)

University of Muenster - Finance Center Muenster ( email )

Universitaetsstraße 14-16
Muenster, 48143
Germany

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/en/the-fcm/lsdfe/team/rene-flacke

Frederik T. Middelhoff

University of Muenster - Finance Center Muenster ( email )

Schlossplatz 2
Muenster
Germany

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