Option Implied Volatility Factors and the Cross-Section of Market Risk Premia

The main goal of this paper is to study market volatility risk premia. I develop a multifactor model by proposing a pricing kernel, where the market return, the diffusion volatility and the jump volatility are fundamental factors that change the investment opportunity set. Based on estimates of the diffusion and jump volatility factors using an enriched dataset including S&P500 index returns, index options and VIX, the paper finds negative market prices of volatility factors in the crosssection of stock returns. The findings are consistent with risk-based interpretations of the value and size premia. They indicate that the value effect is mainly related to the diffusion (long-run) volatility factor, whereas the size effect is associated to both the diffusion and jump (short-run) volatility factors.