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

Andreou, P.

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