A Tale of Two Option Markets: Pricing Kernels and Volatility Risk

Zhaogang Song and Dacheng Xiu

No 2014-58, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Using prices of both S&P 500 options and recently introduced VIX options, we study asset pricing implications of volatility risk. While pointing out the joint pricing kernel is not identified nonparametrically, we propose model-free estimates of marginal pricing kernels of the market return and volatility conditional on the VIX. We find that the pricing kernel of market return exhibits a decreasing pattern given either a high or low VIX level, whereas the unconditional estimates present a U-shape. Hence, stochastic volatility is the key state variable responsible for the U-shape puzzle documented in the literature. Finally, our estimates of the volatility pricing kernel feature a U-shape, implying that investors have high marginal utility in both high and low volatility states.

Keywords: Pricing kernel; volatility risk; VIX option; state-price density (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2014-01-30
New Economics Papers: this item is included in nep-cfn, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Related works:
Journal Article: A tale of two option markets: Pricing kernels and volatility risk (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2014-58

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