Effects of market default risk on index option risk-neutral moments

Andreou, P.

doi:10.1080/14697688.2014.1000367

Effects of market default risk on index option risk-neutral moments

Andreou, P.

Authors

Professor Panayiotis Andreou panayiotis.andreou@durham.ac.uk
Professor

Abstract

We investigate the relative importance of market default risk in explaining the time variation of the S&P 500 Index option-implied risk-neutral moments. The results demonstrate that market default risk is positively (negatively) related to the index risk-neutral volatility and skewness (kurtosis). These relations are robust in the presence of other factors relevant to the dynamics and microstructure nature of the spot and option markets. Overall, this study sheds light on a set of economic determinants which help to understand the daily evolution of the S&P 500 Index option-implied risk-neutral distributions. Our findings offer explanations of why theoretical predictions of option pricing models are not consistent with what is observed in practice and provide support that market default risk is important to asset pricing.

Citation

Andreou, P. (2015). Effects of market default risk on index option risk-neutral moments. Quantitative Finance, 15(12), 2021-2040. https://doi.org/10.1080/14697688.2014.1000367

Journal Article Type	Article
Acceptance Date	Dec 4, 2014
Online Publication Date	Mar 12, 2015
Publication Date	Dec 1, 2015
Deposit Date	Jan 4, 2016
Publicly Available Date	Sep 12, 2016
Journal	Quantitative Finance
Print ISSN	1469-7688
Electronic ISSN	1469-7696
Publisher	Taylor and Francis Group
Peer Reviewed	Peer Reviewed
Volume	15
Issue	12
Pages	2021-2040
DOI	https://doi.org/10.1080/14697688.2014.1000367
Keywords	Market default risk, Implied volatility smirk, Risk-neutral moments, Market leverage, G12, G13, G14.
Public URL	https://durham-repository.worktribe.com/output/1424117

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Copyright Statement
This is an Accepted Manuscript of an article published by Taylor & Francis Group in Quantitative Finance on 12/03/2015, available online at: http://www.tandfonline.com/10.1080/14697688.2014.1000367.