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Lévy jump risk: Evidence from options and returns

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  • Ornthanalai, Chayawat

Abstract

Using index options and returns from 1996 to 2009, I estimate discrete-time models where asset returns follow a Brownian increment and a Lévy jump. Time variations in these models are generated with an affine GARCH, which facilitates the empirical implementation. I find that the risk premium implied by infinite-activity jumps contributes to more than half of the total equity premium and dominates that of the Brownian increments suggesting that it is more representative of the risks present in the economy. Overall, my findings suggest that infinite-activity jumps, instead of the Brownian increments, should be the default modeling choice in asset pricing models.

Suggested Citation

  • Ornthanalai, Chayawat, 2014. "Lévy jump risk: Evidence from options and returns," Journal of Financial Economics, Elsevier, vol. 112(1), pages 69-90.
    • Handle: RePEc:eee:jfinec:v:112:y:2014:i:1:p:69-90
    DOI: 10.1016/j.jfineco.2013.11.009
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    More about this item

    Keywords

    Lévy process; Discrete-time; GARCH; Option valuation; Risk premium;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • C46 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Specific Distributions
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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