Working Paper: NBER ID: w21491
Authors: Torben G. Andersen; Nicola Fusari; Viktor Todorov
Abstract: We study short-term market risks implied by weekly S&P 500 index options. The introduction of weekly options has dramatically shifted the maturity profile of traded options over the last five years, with a substantial proportion now having expiry within one week. Economically, this reflects a desire among investors for actively managing their exposure to very short-term risks. Such short-dated options provide an easy and direct way to study market volatility and jump risks. Unlike longer-dated options, they are largely insensitive to the risk of intertemporal shifts in the economic environment, i.e., changes in the investment opportunity set. Adopting a novel general semi-nonparametric approach, we uncover variation in the shape of the negative market jump tail risk which is not spanned by market volatility. Incidents of such tail shape shifts coincide with serious mispricing of standard parametric models for longer-dated options. As such, our approach allows for easy identification of periods of heightened concerns about negative tail events on the market that are not always "signaled" by the level of market volatility and elude standard asset pricing models.
Keywords: short-term options; market volatility; jump risks; risk-neutral distribution; tail risk
JEL Codes: C01; C14; C52; C58; G12; G13; G17; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trading of weekly options (G13) | market efficiency (G14) |
| short-dated options (G13) | identification of jump risks and volatility (G17) |
| negative market jump tail risk (G19) | mispricing in standard parametric models for longer-dated options (G13) |
| heightened tail risk (G40) | significant market events (G14) |
| short-dated options (G13) | perceived downside short-term tail risks (G41) |