The Impact of Jumps in Volatility and Returns
Michael Johannes and
No 02-18, Working Papers from Duke University, Department of Economics
This paper examines a class of continuous-time models incorporating jumps in returns and volatility, in addition to diffusive stochastic volatility. We develop a likelihood-based estimation strategy and provide estimates of model parameters, spot volatility, jump times and jump sizes using both S&P 500 and Nasdaq 100 index returns. Estimates of jump times, jump sizes and volatility are particularly useful for disentangling the dynamic effects of these factors during periods of market stress, such as those in 1987, 1997 and 1998. Using both formal and informal diagnostics, we find strong evidence for jumps in volatility, even after accounting for jumps in returns. We study the impact of these factors and of estimation risk on option prices.
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Forthcoming in JOURNAL OF FINANCE
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