The price of correlation risk: Evidence from equity options
Driessen,J.J.A.G. Maenhout,P. Vilkov,G.
Driessen,J.J.A.G.
Maenhout,P.
Vilkov,G.
Abstract
We study whether exposure to marketwide correlation shocks affects expected option returns, using data on S&P100 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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Date
2009
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Research Projects
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Citation
Driessen, J J A G, Maenhout, P & Vilkov, G 2009, 'The price of correlation risk : Evidence from equity options', Journal of Finance, vol. 64, no. 3, pp. 1377-1406.