Jumps and Diffusive Variance: A Granular Analysis of Individual Stock Returns

46 Pages Posted: 26 Apr 2021 Last revised: 4 Jun 2021

See all articles by Gang Li

Gang Li

Hong Kong Polytechnic University

Ruicong Li

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Chu Zhang

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Date Written: April 25, 2021

Abstract

Jumps and diffusive changes in stock prices are different ways in which information is reflected in the prices. We use nonparametric methods to decompose returns on individual stocks into jumps and diffusive components. Contrary to the conventional assumption that jump intensity is positively related to diffusive variance, we find abundant evidence that realized jump intensity and diffusive variance are uncorrelated or negatively related for a majority of stocks. The jump-diffusion beta is found to positively contribute to the implied volatility smile of options on individual stocks. We also document a counter-cyclical pattern of realized jump sizes, which challenges the i.i.d. jump size assumption commonly seen in the literature. The findings provide useful guidance on modeling option prices.

Keywords: Jumps, Diffusive Variance, Implied Volatility Smile

JEL Classification: G12

Suggested Citation

Li, Gang and Li, Ruicong and Zhang, Chu, Jumps and Diffusive Variance: A Granular Analysis of Individual Stock Returns (April 25, 2021). HKUST Business School Research Paper No. 2021-027, Available at SSRN: https://ssrn.com/abstract=3833680 or http://dx.doi.org/10.2139/ssrn.3833680

Gang Li

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

Ruicong Li

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay
Kowloon, 999999
Hong Kong

HOME PAGE: http://ruicong-li.github.io

Chu Zhang (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong

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