A. Berndt, A. A. Lookman, and I. Obreja, “Default Risk Premia and Asset Returns,” (Working paper, Carnegie Mellon University, 18 December 2006).
Abstract: This paper investigates the source for common variation in the portion of re-turns observed in U.S. credit markets that is not related to changes in risk free-rates or expected default losses. We extract a latent common component from firm specific changes in default risk premia that is orthogonal to known systematic risk factors during our sample period from 2001 … Read More »
K. Danquah, S. Kasera, B. Lee, and S. Ung, “Local Volatility Calibration Using the ‘Most Likely Path,” (Seminar paper, New York University, 19 December 2006).
Abstract: Why are we interested in calibrating a local volatility surface? It is mostly to price dependent exotic options which are not very liquid and the proper market quotes are not available. Local volatility also gives rise to some interesting relative value trading strategies. There are a number of local volatility calibration methods available, but no one agrees on the … Read More »
V. Di Pietro and G. Vainberg, “Systematic Variance Risk and Firm Characteristics in the Equity Options Market,” (Northwestern University and McGill University, December 2006).
Abstract: We construct synthetic variance swap returns from prices of traded options to investigate the pricing of systematic variance risk in the equity options market. Cross sectional tests reveal no evidence of a negative market variance risk premium. Furthermore, we show that a class of linear factor models cannot simultaneously explain index and equity option prices. In particular, equity options … Read More »
J. Fan and L. Mancini, “Option Pricing with Aggregation of Physical Models and Nonparametric Statistical Learning,” (Swiss Finance Institute, 9 December 2006).
Abstract: Financial models are largely used in option pricing. These physical models capture several salient features of asset price dynamics. The pricing performance can be significantly enhanced when they are combined with nonparametric learning approaches, that empirically learn and correct pricing errors through estimating state price distributions. In this paper, we propose a new semi-parametric method for estimating state price … Read More »
G.M. Constantinides, J.C. Jackwerth, and S. Perrakis, “Mispricing of S&P 500 Index Options,” (Working paper, University of Chicago, University of Konstanz, and Concordia University, 10 November 2006).
Abstract: We document widespread violations of stochastic dominance by one-month S&P 500 index call options market over 1986-2006. These violations imply that a trader can improve her expected utility by engaging in a zero-net-cost trade. We allow the market to be incomplete and also imperfect by introducing transaction costs and bid-ask spreads. Even though pre-crash option prices conform to the … Read More »
R. Battalio and P. Schultz, “Options and the Bubble,” The Journal of Finance 61, no. 5 (October 2006): 2071-2102.
ABSTRACT: Many believe that a bubble existed in Internet stocks in the 1999 to 2000 period, and that short-sale restrictions prevented rational investors from driving Internet stock prices to reasonable levels. In the presence of such short-sale constraints, option and stock prices could decouple during a bubble. Using intraday options data from the peak of the Internet bubble, we find … Read More »
M. Cremers, J. Driessen, and P. Maenhout, “Explaining the Level of Credit Spreads: Option-Implied Jump Risk Premia in a Firm Value Model,” (Working paper, Yale School of Management, University of Amsterdam Business School, and INSEAD, October 2006).
Abstract: Prices of equity index put options contain information on the price of systematic downward jump risk. We use a structural jump-diffusion firm value model to assess the level of credit spreads that is generated by option-implied jump risk premia. In our compound option pricing model, an equity index option is an option on a portfolio of call options on … Read More »
E. Zitzewitz, “Price Discovery among the Punters: Using New Financial Betting Markets to Predict Intraday Volatility,” (Working paper, Stanford University, July 2006).
Abstract: The migration of financial betting to prediction market exchanges in the last 5 years has facilitated the creation of contracts that do not correspond to a security traded on a traditional exchange. The most popular of these have been binary options on the closing value of Dow Jones Industrial Average (DJIA). Prices of these options imply expectations of volatility … Read More »
G. Bakshi and L. Wu, “Investor Irrationality and the Nasdaq Bubble,” (Paper presented at the meeting of the Western Finance Association, Keystone, Colorado, 22 June 2006).
ABSTRACT: This paper investigates whether the rise and fall of the Nasdaq at the turn of the century can be justified by changes in return risk, and whether investors are driven by irrational euphoria with systematic shifts in the market prices of risks (e.g., inexplicable changes in risk aversion and/or subjective probabilities deviating substantially from the objective states of the … Read More »
H.S. Choi and N. Jayaraman, “Is Reversal of Large Stock-Price Declines Caused by Overreaction or Information Asymmetry: Evidence from Stock and Option Markets,” (Seminar paper, Georgia Tech Finance Workshop, June 2006).
Abstract: We reexamine the role of option markets in the reversal process of stock prices following stock price declines of 10 percent or more. We find that the positive rebounds for non-optionable firms are caused by an abnormal increase in bid-ask spread on and before the large price decline date. On the other hand, the bid-ask spreads for optionable firms … Read More »