The leverage effect and the basket-index put spread

Jennie Bai, Robert S. Goldstein and Fan Yang

Journal of Financial Economics, 2019, vol. 131, issue 1, 186-205

Abstract: Benchmark models that exogenously specify equity dynamics cannot explain the large spread in prices between put options written on individual banks and options written on the bank index during the financial crisis. However, theory requires that asset dynamics be specified exogenously and that endogenously determined equity dynamics exhibit a “leverage effect” that increases put prices by fattening the left tail of the distribution. The leverage effect is larger for puts on individual stocks than for puts on the index, thus increasing the basket-index spread. Time-series and cross-sectional variation in the leverage effect explains option prices well.

Keywords: Leverage effect; Option price; Credit spread; Volatility (search for similar items in EconPapers)
JEL-codes: E44 G01 G13 G21 G28 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:131:y:2019:i:1:p:186-205

DOI: 10.1016/j.jfineco.2018.07.015

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