Review of Financial Studies Vol. 39 No. 3 2026
Option Pricing with Time-Varying Volatility Risk Aversion
Abstract
We introduce a pricing kernel with time-varying volatility risk aversion to explain the observed time variations in the shape of the pricing kernel. When combined with the Heston-Nandi GARCH model, this framework yields a tractable option pricing model in which the variance risk ratio (VRR) emerges as a key variable. We show that the VRR is closely linked to economic fundamentals, as well as sentiment and uncertainty measures. A novel approximation method provides analytical option pricing formulas, and we demonstrate substantial reductions in pricing errors through an empirical application to the S&P 500 index, the CBOE VIX, and option prices.
- DOI
- 10.1093/rfs/hhaf063
- Volume
- 39
- Issue
- 3
- Pages
- 875-924
- Language
- en
- Sources
- openalex crossref