The Factor Structure in Equity Options

Peter Christoffersen, Mathieu Fournier () and Kris Jacobs ()
Additional contact information
Mathieu Fournier: Rotman School of Management, Postal: 105 St.George St Toronto, Toronto, Ontario M5S 3E6, Canada
Kris Jacobs: University of Houston, Postal: Houston, TX 77204-6021, United States

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: Principal component analysis of equity options on Dow-Jones firms reveals a strong factor structure. The first principal component explains 77% of the variation in the equity volatility level, 77% of the variation in the equity option skew, and 60% of the implied volatility term structure across equities. Furthermore, the first principal component has a 92% correlation with S&P500 index option volatility, a 64% correlation with the index option skew, and a 80% correlation with the index option term structure. We develop an equity option valuation model that captures this factor structure. The model allows for stochastic volatility in the market return and also in the idiosyncratic part of firm returns. The model predicts that firms with higher betas have higher implied volatilities, and steeper moneyness and term structure slopes. We provide a tractable approach for estimating the model on a large set of index and equity option data on which the model provides a good fit. The equity option data support the cross-sectional implications of the estimated model.

Keywords: factor models; equity options; implied volatility; option-implied beta (search for similar items in EconPapers)
JEL-codes: G10 G12 G13 (search for similar items in EconPapers)
Pages: 58
Date: 2013
New Economics Papers: this item is included in nep-cfn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://repec.econ.au.dk/repec/creates/rp/13/rp13_47.pdf (application/pdf)

Related works:
Journal Article: The Factor Structure in Equity Options (2018)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:aah:create:2013-47

Access Statistics for this paper

More papers in CREATES Research Papers from Department of Economics and Business Economics, Aarhus University
Bibliographic data for series maintained by ().