The risk and return of equity and credit index options

Hitesh Doshi, Jan Ericsson, Mathieu Fournier and Sang Byung Seo

Journal of Financial Economics, 2024, vol. 161, issue C

Abstract: We develop a structural credit risk model, which allows us to price equity/credit indices and their options through the asset dynamics of index constituents. We estimate the model via MLE and find that equity and credit index option prices are well explained out-of-sample. Contrary to recent empirical findings, the two option markets are not inconsistently priced through the lens of our model. Returns on both options, while extreme, do not indicate any evidence of mispricing. Our analysis suggests that jointly addressing the pricing of various instruments requires properly attributing three different sources of systematic risk: asset, variance, and jump risks.

Keywords: Structural credit risk model; Compound options; Credit index options; Pricing consistency (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:161:y:2024:i:c:s0304405x24001557

DOI: 10.1016/j.jfineco.2024.103932

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