Journal
QUANTITATIVE FINANCE
Volume 15, Issue 12, Pages 2021-2040Publisher
ROUTLEDGE JOURNALS, TAYLOR & FRANCIS LTD
DOI: 10.1080/14697688.2014.1000367
Keywords
Market default risk; Implied volatility smirk; Risk-neutral moments; Market leverage; G12; G13; G14
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We investigate the relative importance of market default risk in explaining the time variation of the S&P 500 Index option-implied risk-neutral moments. The results demonstrate that market default risk is positively (negatively) related to the index risk-neutral volatility and skewness (kurtosis). These relations are robust in the presence of other factors relevant to the dynamics and microstructure nature of the spot and option markets. Overall, this study sheds light on a set of economic determinants which help to understand the daily evolution of the S&P 500 Index option-implied risk-neutral distributions. Our findings offer explanations of why theoretical predictions of option pricing models are not consistent with what is observed in practice and provide support that market default risk is important to asset pricing.
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