The World Price of Jump and Volatility Risk∗

This paper studies volatility and jump risk from a conditional and an international perspective using data on index options from US (S&P 500 index options), European (FTSE index options) and Asian markets (Nikkei index options). In order to explain the cross-section of expected option returns across strikes and maturities, we focus on return-based multi-factor models, using returns on straddles and out-of-the-money put options as proxies for volatility and jump risk factors. For each market separately, we provide evidence that volatility and jump risk are priced risk factors. There is however little evidence of global unconditional pricing of option returns. Next we investigate the presence of time-variation in the cross-market relationships, and Þnd evidence that UK and US option markets have become increasingly interrelated. Incorporating these time-varying patterns in conditional factor pricing models improves their Þt substantially and generates some evidence of global pricing. ∗We would like to thank the BSI Gamma Foundation for Þnancial support. †University of Amsterdam, Finance Group, Faculty of Economics and Econometrics, Roetersstraat 11, 1018 WB Amsterdam, the Netherlands. Email: [email protected]. ‡INSEAD, Finance Department, Boulevard de Constance, 77305 Fontainebleau Cedex, France. Email: [email protected].