Level and slope of volatility smiles in long-run risk models

Nicole Branger, Paulo Rodrigues, Christian Schlag

Research output: Contribution to journalArticleAcademicpeer-review

Abstract

We propose a long-run risk model with stochastic volatility, a time-varying mean reversion level of volatility, and jumps in the state variables. The special feature of our model is that the jump intensity is not affine in the conditional variance but driven by a separate process. We show that this separation of jump risk from volatility risk is needed to match the empirically weak link between the level and the slope of the implied volatility smile for S&P 500 options. (C) 2017 Elsevier B.V. All rights reserved.

Original languageEnglish
Pages (from-to)95-122
Number of pages28
JournalJournal of Economic Dynamics & Control
Volume86
DOIs
Publication statusPublished - Jan 2018

JEL classifications

  • g12 - "Asset Pricing; Trading volume; Bond Interest Rates"

Keywords

  • Asset pricingEpstein–Zin preferencesJump riskStochastic volatilityLevel and slope of implied volatility smile
  • STOCK RETURNS
  • PREMIUMS
  • Level and slope of implied volatility smile
  • Stochastic volatility
  • Epstein-Zin preferences
  • OPTIONS
  • Asset pricing
  • Jump risk
  • ASSET RETURNS
  • JUMP-RISK
  • CONSUMPTION

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