Working Paper: NBER ID: w28941
Authors: Christopher L. Culp; Mihir Gandhi; Yoshio Nozawa; Pietro Veronesi
Abstract: We propose implied spreads (IS) and normalized implied spreads (NIS) as simple measures to characterize option prices. IS is the credit spread of an option’s implied bond, the portfolio long a risk-free bond and short a put option. NIS normalizes IS by the risk-neutral default probability and reflects tail risk. IS and NIS are countercyclical and predict implied bond returns, while neither, like implied volatility, predicts put returns. These opposite predictability results are consistent with a stochastic volatility, stochastic jump intensity model, as put premia increase in volatility but decrease in jump intensity, while implied bond premia increase in both.
Keywords: option pricing; risk premia; implied spreads
JEL Codes: G12; G13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| implied spreads (is) (F14) | future implied bond returns (G12) |
| normalized implied spreads (nis) (G12) | future implied bond returns (G12) |
| economic environment (P42) | implied spreads (is) (F14) |
| economic environment (P42) | normalized implied spreads (nis) (G12) |
| normalized implied spreads (nis) (G12) | implied spreads (is) (F14) |
| implied volatility (C69) | future option returns (G13) |