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Pricing of risk in credit and equity index options-A role for option order flow?

Author

Listed:
  • Pierre Collin-Dufresne

    (Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; National Bureau of Economic Research (NBER))

  • Anders B. Trolle

    (Copenhagen Business School)

Abstract

We find consistent evidence across ratings and regions that delta-hedged credit index options have large negative Sharpe ratios and much more so than their equity index counterparts. Risk-factors extracted from equity index options have only moderate explanatory power for the time-series and cross-sectional variation in credit option returns, while a single credit-specific factor explains much of the remaining variation. We link this factor to credit option order flow in a manner that is consistent with the predictions of a demand-based option pricing model, where order-flow risk is priced in equilibrium.

Suggested Citation

  • Pierre Collin-Dufresne & Anders B. Trolle, 2024. "Pricing of risk in credit and equity index options-A role for option order flow?," Swiss Finance Institute Research Paper Series 24-53, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2453
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    More about this item

    Keywords

    credit and equity index options; demand-based pricing; Credit risk;
    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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