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Model Specification and Risk Premia: Evidence from Futures Options
__By Mark Broadie, Mikhail Chernov and Michael Johannes__
__ABSTRACT__
This paper examines model specification issues and provides estimates diffusive and jump risk premia using S&P futures option prices from 1987 to 2003. We first develop a timeseries test to detect the presence of jumps in volatility, and find strong evidence in support of their presence. Next, using the cross-section of option prices, we find strong evidence for jumps in prices and modest evidence for jumps in volatility based on model fit. The evidence points toward economically and statistically significant jump risk premium, which are important for understanding option returns.
[http://www.afajof.org/journal/forth_abstract.asp?ref=330|Forthcoming in the Journal of Finance] and available for a limited time.
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