We study international integration of markets for jump and volatility risk, using index option data for the main global markets. To explain the cross-section of expected option returns we focus on return-based multi-factor models. For each market separately, we provide evidence that volatility and jump risk are priced risk factors. There is little evidence, however, of global unconditional pricing of these risks. We show that UK and US option markets have become increasingly interrelated, and using conditional pricing models generates some evidence of international pricing. Finally, the benefits of diversifying jump and volatility risk internationally are substantial, but declining.

Abstract This paper solves numerically the intertemporal consumption and portfolio choice problem of an infinitely-lived investor who faces a time-varying equity premium. The solutions we obtain are very similar to the approximate analytical solutions of Campbell and Viceira (1999), except at the upper extreme of the state space where both the numerical consumption and portfolio rules flatten out. We also consider a constrained version of the problem in which the investor faces borrowing and short-sales restrictions. These constraints bind when the equity premium moves away from its mean in either direction, and are particularly severe for risk-tolerant investors. The constraints have substantial effects on optimal consumption, but much more modest effects on optimal portfolio choice in the region of the state space where they are not binding. JEL classification: G12.

ABSTRACT We study whether exposure to marketwide correlation shocks affects expected option returns, using data on S&P100 index options, options on all components, and stock returns. We find evidence of priced correlation risk based on prices of index and individual variance risk. A trading strategy exploiting priced correlation risk generates a high alpha and is attractive for CRRA investors without frictions. Correlation risk exposure explains the cross‐section of index and individual option returns well. The correlation risk premium cannot be exploited with realistic trading frictions, providing a limits‐to‐arbitrage interpretation of our finding of a high price of correlation risk.

ABSTRACT We study aversion to model ambiguity and misspecification in dynamic portfolio choice. Risk‐averse investors (relative risk aversion ) fear return persistence, while risk‐tolerant investors () fear mean reversion, when confronting model misspecification concerns of identically and independently distributed (IID) returns. The intuition is that risk‐averse investors, who want to hedge intertemporally, endogenously fear return persistence, which precludes hedging. A log investor is myopic and unaffected by model misspecification, therefore only worrying about model ambiguity. Our model can generate belief scarring, nonparticipation in equity markets, and extrapolative return expectations. Extending beyond IID returns, we study model misspecification for a mean‐reverting Sharpe ratio.

This paper introduces measures of volatility and jump risk that are based on individual stock options to explain credit spreads on corporate bonds. Implied volatilities of individual options are shown to contain useful information for credit spreads and improve on historical volatilities when explaining the cross-sectional and time-series variation in a panel of corporate bond spreads. Both the level of individual implied volatilities and (to a lesser extent) the implied-volatility skew matter for credit spreads. Detailed principal component analysis shows that a large part of the time-series variation in credit spreads can be explained in this way.