Characteristic Function-Based Factor Modeling of Affine Jump-Diffusions using Options

H. Peter Boswijk, Roger J. A. Laeven, Niels Marijnen and Evgenii Vladimirov
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H. Peter Boswijk: University of Amsterdam
Roger J. A. Laeven: University of Amsterdam
Niels Marijnen: University of Amsterdam
Evgenii Vladimirov: Erasmus University Rotterdam

No 26-026/III, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We develop a framework to analyze option markets using factor modeling techniques, offering a novel method to study how many and which risk factors drive the price process of a single asset. We exploit information contained in option prices to construct observations on the characteristic function of the returns on the underlying asset, without having to specify a parametric model. Our asymptotic setting is one in which the number of observed options, with varying strikes, tends to infinity. We establish consistency and asymptotic normality of the option-based log-characteristic function estimator, and provide a feasible central limit theorem that can be used for testing. Based on this, we prove that principal component analysis is able to extract the factors of affine jump-diffusions. We show in Monte Carlo simulations that our has good finite-sample properties. An empirical application indicates that the main factor driving S&P 500 returns is a stochastic variance process, along with a factor related to left-tail jump risk, and that at least two factors are needed to explain higher-order moments with reasonable accuracy.

Keywords: Options; Factor Model; Characteristic Function; Affine Jump-Diffusion (search for similar items in EconPapers)
JEL-codes: C14 C38 G13 (search for similar items in EconPapers)
Date: 2026-05-29
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