Pricing of risk in credit and equity index options-A role for option order flow?

Pierre Collin-Dufresne and Anders B. Trolle
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Pierre Collin-Dufresne: Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; National Bureau of Economic Research (NBER)
Anders B. Trolle: Copenhagen Business School

No 24-53, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We find consistent evidence across ratings and regions that delta-hedged credit index options have large negative Sharpe ratios and much more so than their equity index counterparts. Risk-factors extracted from equity index options have only moderate explanatory power for the time-series and cross-sectional variation in credit option returns, while a single credit-specific factor explains much of the remaining variation. We link this factor to credit option order flow in a manner that is consistent with the predictions of a demand-based option pricing model, where order-flow risk is priced in equilibrium.

Keywords: credit and equity index options; demand-based pricing; Credit risk (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Pages: 95 pages
Date: 2024-09
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2453

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