Jump variance risk: Evidence from option valuation and stock returns

Hsuan‐Ling Chang, Yen‐Cheng Chang, Hung‐Wen Cheng, Po‐Hsiang Peng and Kevin Tseng
Authors registered in the RePEc Author Service: Yen-Cheng Chang

Journal of Futures Markets, 2019, vol. 39, issue 7, 890-915

Abstract: We study jump variance risk by jointly examining both stock and option markets. We develop a GARCH option pricing model with jump variance dynamics and a nonmonotonic pricing kernel featuring jump variance risk premium. The model yields a closed‐form option pricing formula and improves in fitting index options from 1996 to 2015. The model‐implied jump variance risk premium has predictive power for future market returns. In the cross‐section, heterogeneity in exposures to jump variance risk leads to a 6% difference in risk‐adjusted returns annually.

Date: 2019
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