TY - JOUR
T1 - General equilibrium pricing of options with habit formation and event risks
AU - Du, Du
PY - 2011/2
Y1 - 2011/2
N2 - This paper proposes a general equilibrium model that explains the pricing of the S&P 500 index options. The central ingredients are a peso component in the consumption growth rate and the time-varying risk aversion induced by habit formation which amplifies consumption shocks. The amplifying effect generates the excess volatility and a large jump-risk premium which combine to produce a pronounced volatility smirk for index options. The time-varying volatility and jump-risk premiums explain the observed state-dependent smirk patterns. Besides volatility smirks, the model has a variety of other implications which are broadly consistent with the aggregate stock and option market data. © 2010 Elsevier B.V.
AB - This paper proposes a general equilibrium model that explains the pricing of the S&P 500 index options. The central ingredients are a peso component in the consumption growth rate and the time-varying risk aversion induced by habit formation which amplifies consumption shocks. The amplifying effect generates the excess volatility and a large jump-risk premium which combine to produce a pronounced volatility smirk for index options. The time-varying volatility and jump-risk premiums explain the observed state-dependent smirk patterns. Besides volatility smirks, the model has a variety of other implications which are broadly consistent with the aggregate stock and option market data. © 2010 Elsevier B.V.
KW - Economic disasters
KW - Habit formation
KW - Jump-risk premium
KW - Volatility smirk
UR - http://www.scopus.com/inward/record.url?scp=78650309034&partnerID=8YFLogxK
UR - https://www.scopus.com/record/pubmetrics.uri?eid=2-s2.0-78650309034&origin=recordpage
U2 - 10.1016/j.jfineco.2010.09.001
DO - 10.1016/j.jfineco.2010.09.001
M3 - 21_Publication in refereed journal
VL - 99
SP - 400
EP - 426
JO - Journal of Financial Economics
JF - Journal of Financial Economics
SN - 0304-405X
IS - 2
ER -