Negative Volatility Risk Premium: Evidence from the LIFFE Equity Options

• Main Authors: Yin-Jung Chen, 陳盈榕
• Other Authors: Bing-Huei Lin
• Format: Others
• Language: en_US
• Published: 2009
• Online Access: http://ndltd.ncl.edu.tw/handle/34292307101892878062

博士 === 國立臺灣科技大學 === 企業管理系 === 97 === As evinced by non-normal stylized characteristics in equity returns, this study adopts a moment-adjusted option pricing model (Corrado and Su, 1996) to extract volatility risk premia from LIFFE equity option prices. We incorporate the moment-adjusted option delta hedge ratio to mitigate the effect of model misspecification. From the results of equity index options, we observe several phenomena. First, the delta-hedged gains are negative. Second, with a correction for model misspecification, higher-order moments measures show less significance and the volatility risk premium still plays a key role in affecting delta-hedged gains. Our empirical evidence supports the existence of negative volatility risk premium in LIFFE equity index options. A negative volatility risk premium suggests that option buyers are willing to pay a premium to buy options as a hedge to the market portfolio. Moreover, the empirical results have shown the existence of a negative market volatility risk premium in U.K. individual stock option prices, and the idiosyncratic volatility appears to be priced. This study further verifies the contribution of common macro factors to the pricing of volatility risk in individual equity options. The analysis of this paper allows for multifactor models of individual return volatility. We find that shocks to an index of industrial production, unanticipated inflation, and twists in the yield curve are negatively correlated with Black-Scholes and moment-adjusted delta-hedged gains. The negative volatility risk premium represents that option investors are willing to pay more to hedge against the shocks to those macro factors and idiosyncratic risk.