The Puzzle of Index Option Returns

George Constantinides, Jens Carsten Jackwerth () and Alexi Savov
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Jens Carsten Jackwerth: Department of Economics, University of Konstanz, Germany

No 2011-17, Working Paper Series of the Department of Economics, University of Konstanz from Department of Economics, University of Konstanz

Abstract: We document that the leverage-adjusted returns on S&P 500 index call and put portfolios are decreasing in their strike-to-price ratio over 1986-2009, contrary to the prediction of the Black-Scholes-Merton model. We test a large number of plausible factor models in order to learn what drives the violations of the Black-Scholes-Merton model. Consistent with the picture that crisis-related factors operate across the equities and index options markets, factors which capture jumps in market volatility, jumps in the market index, and changes in liquidity work reasonably well in explaining the cross-section of index option returns, even when we impose the restriction that the premia are estimated from the universe of equities. Furthermore, the factor that captures jumps in market volatility also reduces the pricing errors of the 25 Fama-French portfolios by more than Size and only a bit less than Value.

Keywords: index option returns; option mispricing; volatility jumps; price jumps; liquidity; market efficiency (search for similar items in EconPapers)
JEL-codes: G11 G13 G14 (search for similar items in EconPapers)
Pages: 66 pages
Date: 2011-05-24
New Economics Papers: this item is included in nep-cfn and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: The Puzzle of Index Option Returns (2013)
Working Paper: The Puzzle of Index Option Returns (2012)
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