Journal of Financial Economics Vol. 99 No. 2 2011
General equilibrium pricing of options with habit formation and event risks
Abstract
This paper proposes a general equilibrium model that explains the pricing of the S&P 500 index options. The central ingredients are a peso component in the consumption growth rate and the time-varying risk aversion induced by habit formation which amplifies consumption shocks. The amplifying effect generates the excess volatility and a large jump-risk premium which combine to produce a pronounced volatility smirk for index options. The time-varying volatility and jump-risk premiums explain the observed state-dependent smirk patterns. Besides volatility smirks, the model has a variety of other implications which are broadly consistent with the aggregate stock and option market data.
- DOI
- 10.1016/j.jfineco.2010.09.001
- Volume
- 99
- Issue
- 2
- Pages
- 400-426
- Language
- en
- Sources
- openalex crossref bibtex:phds-export.bib