Pricing of Risk in Credit and Equity Index Options - A Role for Option Order Flow?

Pierre Collin-Dufresne and Anders Trolle

No 19580, CEPR Discussion Papers from Centre for Economic Policy Research

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 risk; Credit and equity index options; Demand-based pricing (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2024-10
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