A Tale of Two Option Markets: Pricing Kernels and Volatility Risk

44 Pages Posted: 31 May 2017

See all articles by Zhaogang Song

Zhaogang Song

Johns Hopkins University - Carey Business School

Dacheng Xiu

University of Chicago - Booth School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: 2014-01-30

Abstract

Using prices of both S&P 500 options and recently introduced VIX options, we study asset pricing implications of volatility risk. While pointing out the joint pricing kernel is not identified nonparametrically, we propose model-free estimates of marginal pricing kernels of the market return and volatility conditional on the VIX. We find that the pricing kernel of market return exhibits a decreasing pattern given either a high or low VIX level, whereas the unconditional estimates present a U-shape. Hence, stochastic volatility is the key state variable responsible for the U-shape puzzle documented in the literature. Finally, our estimates of the volatility pricing kernel feature a U-shape, implying that investors have high marginal utility in both high and low volatility states.

Keywords: Pricing kernel, volatility risk, VIX option, state-price density

JEL Classification: G12, G13

Suggested Citation

Song, Zhaogang and Xiu, Dacheng, A Tale of Two Option Markets: Pricing Kernels and Volatility Risk (2014-01-30). FEDS Working Paper No. 2014-58, Available at SSRN: https://ssrn.com/abstract=2976966

Zhaogang Song (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Dacheng Xiu

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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