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The risk and return of equity and credit index options

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  • Doshi, Hitesh
  • Ericsson, Jan
  • Fournier, Mathieu
  • Seo, Sang Byung

Abstract

We develop a structural credit risk model, which allows us to price equity/credit indices and their options through the asset dynamics of index constituents. We estimate the model via MLE and find that equity and credit index option prices are well explained out-of-sample. Contrary to recent empirical findings, the two option markets are not inconsistently priced through the lens of our model. Returns on both options, while extreme, do not indicate any evidence of mispricing. Our analysis suggests that jointly addressing the pricing of various instruments requires properly attributing three different sources of systematic risk: asset, variance, and jump risks.

Suggested Citation

  • Doshi, Hitesh & Ericsson, Jan & Fournier, Mathieu & Seo, Sang Byung, 2024. "The risk and return of equity and credit index options," Journal of Financial Economics, Elsevier, vol. 161(C).
    • Handle: RePEc:eee:jfinec:v:161:y:2024:i:c:s0304405x24001557
    DOI: 10.1016/j.jfineco.2024.103932
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    More about this item

    Keywords

    Structural credit risk model; Compound options; Credit index options; Pricing consistency;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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