The price of correlation risk: Evidence from equity options

J.J.A.G. Driessen, P. Maenhout, G. Vilkov

Research output: Contribution to journalArticleScientificpeer-review

123 Citations (Scopus)

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.
Original languageEnglish
Pages (from-to)1377-1406
JournalJournal of Finance
Volume64
Issue number3
Publication statusPublished - 2009

Fingerprint Dive into the research topics of 'The price of correlation risk: Evidence from equity options'. Together they form a unique fingerprint.

  • Cite this