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Volatility risk premium decomposition of LIFFE equity options

Author

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  • Lin, Bing-Huei
  • Lin, Yueh-Neng
  • Chen, Yin-Jung

Abstract

This study extends Bakshi and Kapadia's (2003b) framework to a multi-factor model to verify the common macro-factors attributed to the price of volatility risk in U.K. equity options. The results point out the presence of a negative risk premium and indicate that both idiosyncratic volatility and macro-factor volatilities arising from shocks to an index of industrial production and unanticipated inflation are priced in the individual LIFFE equity options. The evidence suggests that option investors are willing to pay for hedging against the shocks to those macro-factors and idiosyncratic risk.

Suggested Citation

  • Lin, Bing-Huei & Lin, Yueh-Neng & Chen, Yin-Jung, 2012. "Volatility risk premium decomposition of LIFFE equity options," International Review of Economics & Finance, Elsevier, vol. 24(C), pages 315-326.
    • Handle: RePEc:eee:reveco:v:24:y:2012:i:c:p:315-326
    DOI: 10.1016/j.iref.2012.04.002
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    References listed on IDEAS

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    Cited by:

    1. Tzang, Shyh-Weir & Wang, Chou-Wen & Yu, Min-Teh, 2016. "Systematic risk and volatility skew," International Review of Economics & Finance, Elsevier, vol. 43(C), pages 72-87.
    2. Lin, Yueh-Neng & Lin, Anchor Y., 2016. "Using VIX futures to hedge forward implied volatility risk," International Review of Economics & Finance, Elsevier, vol. 43(C), pages 88-106.

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    More about this item

    Keywords

    Macro-factors; Volatility risk premium; Idiosyncratic volatility risk; Delta-neutral portfolio; Moment-adjusted option pricing formula;
    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
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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