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Jump variance risk: Evidence from option valuation and stock returns

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  • Hsuan‐Ling Chang
  • Yen‐Cheng Chang
  • Hung‐Wen Cheng
  • Po‐Hsiang Peng
  • Kevin Tseng

Abstract

We study jump variance risk by jointly examining both stock and option markets. We develop a GARCH option pricing model with jump variance dynamics and a nonmonotonic pricing kernel featuring jump variance risk premium. The model yields a closed‐form option pricing formula and improves in fitting index options from 1996 to 2015. The model‐implied jump variance risk premium has predictive power for future market returns. In the cross‐section, heterogeneity in exposures to jump variance risk leads to a 6% difference in risk‐adjusted returns annually.

Suggested Citation

  • Hsuan‐Ling Chang & Yen‐Cheng Chang & Hung‐Wen Cheng & Po‐Hsiang Peng & Kevin Tseng, 2019. "Jump variance risk: Evidence from option valuation and stock returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(7), pages 890-915, July.
    • Handle: RePEc:wly:jfutmk:v:39:y:2019:i:7:p:890-915
    DOI: 10.1002/fut.22009
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    3. Jie-Cao He & Hsing-Hua Chang & Ting-Fu Chen & Shih-Kuei Lin, 2023. "Upside and downside correlated jump risk premia of currency options and expected returns," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-58, December.
    4. Guanghua Lian & Robert J. Elliott & Petko Kalev & Zhaojun Yang, 2022. "Approximate pricing of American exchange options with jumps," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(6), pages 983-1001, June.

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