Treasury option returns and models with unspanned risks

Gurdip Bakshi, John Crosby, Xiaohui Gao and Jorge W. Hansen

Journal of Financial Economics, 2023, vol. 150, issue 3

Abstract: We document the phenomenon that average excess returns of out-of-the-money puts and calls on bond futures are negative, both unconditionally and conditionally on economic states. To explain these findings, we develop economically motivated restrictions in the context of a theory in which the pricing kernel is a general diffusion process with spanned and unspanned components. Our reconciliation is a framework that introduces market incompleteness and priced unspanned volatility risks, allowing for time-varying downside and upside futures risk premiums. The estimated model shows consistency with data on bond yields, yield volatilities, bond futures return volatilities, option prices, and option risk premiums.

Keywords: Options on futures on Treasury bonds; Interest-rate models; Option risk premiums; Unspanned risks in the pricing kernel (search for similar items in EconPapers)
JEL-codes: G12 G13 G14 G24 G32 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:150:y:2023:i:3:s0304405x23001769

DOI: 10.1016/j.jfineco.2023.103736

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