The Pricing of Volatility and Jump Risks in the Cross-Section of Index Option Returns

42 Pages Posted: 28 Sep 2019 Last revised: 7 Feb 2021

See all articles by Guanglian Hu

Guanglian Hu

The University of Sydney - Discipline of Finance

Yuguo Liu

University of Houston - C.T. Bauer College of Business

Date Written: February 4, 2021

Abstract

Existing studies relate the puzzling low average returns on out-of-the-money index call and put
options to non-standard preferences. We argue the low option returns are primarily due to the
pricing of market volatility risk. When volatility risk is priced, expected option returns match
the realized average option returns. Moreover, consistent with its theoretical effect on expected
option returns, the volatility risk premium is positively related to future index option returns and
this relationship is stronger for OTM options and ATM straddles. Lastly, we find the jump risk
premium contributes to some portion of OTM put option returns.

Keywords: volatility risk premium; jump risk premium; expected option returns; the cross-section of index option returns

JEL Classification: G12 G13

Suggested Citation

Hu, Guanglian and Liu, Yuguo, The Pricing of Volatility and Jump Risks in the Cross-Section of Index Option Returns (February 4, 2021). Available at SSRN: https://ssrn.com/abstract=3455794 or http://dx.doi.org/10.2139/ssrn.3455794

Guanglian Hu (Contact Author)

The University of Sydney - Discipline of Finance ( email )

Room 543 H69 Codrington Building
University of Sydney
Sydney, NSW 2006
Australia

Yuguo Liu

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

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