Risk aversion,fanning preference and volatility smirk on S&P 500 index options |
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Authors: | Jian Chen Chenghu Ma |
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Affiliation: | 1. Department of Finance, School of Economics, Xiamen University, Xiamen, P. R. China;2. Finance Research Center &3. School of Management, Fudan University, Shanghai, P. R. China |
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Abstract: | This article proposes a novel way of pricing S&P 500 index options in the presence of jump risk. Our analysis is built upon an equilibrium option pricing rule for a representative agent economy. In particular, we use the weighted utility’s certainty equivalent to specify agent’s risk preference, which displays a fanning-out characteristic. We find that the fanning effect captures a remarkably large portion of the total market risk premium implicit in options. As a result, the model with fanning effect generates pronounced volatility smirks. |
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Keywords: | Recursive utility fanning effect jump risk option smirk |
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