 Expected returns, risk premia, and volatility surfaces implicit in option market pricesAntónio Câmara, Tim Krehbiel () and Weiping Li Journal of Banking & Finance, 2011, vol. 35, issue 1, 215-230 Abstract: This article presents a pure exchange economy that extends Rubinstein (1976) to show how the jump-diffusion option pricing model of Merton (1976) is altered when jumps are correlated with diffusive risks. A non-zero correlation between jumps and diffusive risks is necessary in order to resolve the positively sloped implied volatility term structure inherent in traditional jump diffusion models. Our evidence is consistent with a negative covariance, producing a non-monotonic term structure. For the proposed market structure, we present a closed form asset pricing model that depends on the factors of the traditional jump-diffusion models, and on both the covariance of the diffusive pricing kernel with price jumps and the covariance of the jumps of the pricing kernel with the diffusive price. We present statistical evidence that these covariances are positive. For our model the expected stock return, jump and diffusive risk premiums are non-linear functions of time. Keywords: Jump-diffusion; Term; structure; of; implied; volatilities; Option; pricing; model (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:35:y:2011:i:1:p:215-230 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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