Journal
REVIEW OF ASSET PRICING STUDIES
Volume 8, Issue 2, Pages 183-231Publisher
OXFORD UNIV PRESS
DOI: 10.1093/rapstu/rax021
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Funding
- Bank of Canada
- GRI
- SSHRC
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We nest multiple volatility components, fat tails, and a U-shaped pricing kernel in a single option model and compare their contribution in describing returns and option data. All three features lead to statistically significant model improvements. A U-shaped pricing kernel is economically most important and improves option fit by 17%, on average, and more so for two-factor models. A second volatility component improves the option fit by 9%, on average. Fat tails improve option fit by just over 4%, on average, but more so when a U-shaped pricing kernel is applied. Overall, these threemodel features are complements rather than substitutes: the importance of one feature increases in conjunction with the others.
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