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F. Audriono, D. Colangelo, “Semi-parametric forecasts of the implied volatility surface using regression trees.” (Statistics and Computing, 20 (4), 421-434).

F. Audriono, D. Colangelo, “Semi-parametric forecasts of the implied volatility surface using regression trees.” (Statistics and Computing, 20 (4), 421-434).

Abstract: The role of market jump risk premium implicit in individual equity options has not been examined to date. This paper develops a new factor model for equity returns and option pricing that takes into account the market’s diffusive and jump risks. We estimate the model on a large cross section of equity returns and options. We find that market jump risk embedded in equity options is about 3.18%. This magnitude is consistent with those found in index options pricing studies which suggests that the price structure of equity and index options can be explained in a unified framework. In addition, we show that the market jump and diffusive risk premia affect equity option prices differently. Firms with a larger return compensation for the market diffusive risk have a higher option-implied volatility level while firms with a larger return compensation for market jump risk have steeper option-implied volatility slope.