The Impact of Jumps in Volatility and Returns
University of Wisconsin - Madison - Department of Finance, Investment and Banking
Michael S. Johannes
Columbia Business School - Finance and Economics
University of Chicago - Booth School of Business
Journal of Finance, Vol. 58, pp. 1269-1300, June 2003
This paper examines continuous-time stochastic volatility models incorporating jumps in returns and volatility. We develop a likelihood-based estimation strategy and provide estimates of parameters, spot volatility, jump times, and jump sizes using S&P 500 and Nasdaq 100 index returns. Estimates of jump times, jump sizes, and volatility are particularly useful for identifying the effects of these factors during periods of market stress, such as those in 1987, 1997, and 1998. Using formal and informal diagnostics, we find strong evidence for jumps in volatility and jumps in returns. Finally, we study how these factors and estimation risk impact option pricing.
Date posted: August 31, 2003