The Price of correlation risk: evidence from equity options
Author: Driessen, Joost ; Maenhout, Pascal ; Vilkov, GrigoryINSEAD Area: FinanceIn: Journal of Finance, vol. 64, no. 3, June 2009 Language: EnglishDescription: p. 1377-1406.Type of document: INSEAD ArticleNote: Please ask us for this itemAbstract: We study whether exposure to marketwide correlation shocks affects expected option returns, using data on SandP100 index options, options on all components, and stock returns. We find evidence of priced correlation risk based on prices of index and individual variance risk. A trading strategy exploiting priced correlation risk generates a high alpha and is attractive for CRRA investors without frictions. Correlation risk exposure explains the cross-section of index and individual option returns well. The correlation risk premium cannot be exploited with realistic trading frictions, providing a limits-to-arbitrage interpretation of our finding of a high price of correlation risk| Item type | Current location | Call number | Status | Date due | Barcode | Item holds |
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We study whether exposure to marketwide correlation shocks affects expected option returns, using data on SandP100 index options, options on all components, and stock returns. We find evidence of priced correlation risk based on prices of index and individual variance risk. A trading strategy exploiting priced correlation risk generates a high alpha and is attractive for CRRA investors without frictions. Correlation risk exposure explains the cross-section of index and individual option returns well. The correlation risk premium cannot be exploited with realistic trading frictions, providing a limits-to-arbitrage interpretation of our finding of a high price of correlation risk
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