The Impact of Jumps in Volatility and Returns

Posted: 31 Aug 2003  

Bjorn Eraker

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Michael S. Johannes

Columbia Business School - Finance and Economics

Nick Polson

University of Chicago - Booth School of Business

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Abstract

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.

Suggested Citation

Eraker, Bjorn and Johannes, Michael S. and Polson, Nick, The Impact of Jumps in Volatility and Returns. Journal of Finance, Vol. 58, pp. 1269-1300, June 2003. Available at SSRN: https://ssrn.com/abstract=411145

Bjorn Eraker (Contact Author)

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States

Michael Slater Johannes

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Nick Polson

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7513 (Phone)
773-702-0458 (Fax)

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