The Impact of Jumps in Volatility and Returns

Authors: Eraker B.¹; Johannes M.²; Polson N.³

Source: The Journal of Finance, Volume 58, Number 3, June 2003 , pp. 1269-1300(32)

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Abstract:

This paper examines continuous-time stochastic volatility models incorporating jumps in returns and volatility. We develop a likelihood-based estimation strategy and provide estimates of parameters, spot volatility, jump times, and jump sizes using S&P 500 and Nasdaq 100 index returns. Estimates of jump times, jump sizes, and volatility are particularly useful for identifying the effects of these factors during periods of market stress, such as those in 1987, 1997, and 1998. Using formal and informal diagnostics, we find strong evidence for jumps in volatility and jumps in returns. Finally, we study how these factors and estimation risk impact option pricing.

Document Type: Research article

DOI: http://dx.doi.org/10.1111/1540-6261.00566

Affiliations: 1: Economics Department, Duke University 2: Graduate School of Business, Columbia University 3: Graduate School of Business, University of Chicago

Publication date: 2003-06-01