The Factor Structure in Equity Options. (2nd August 2017)

• Record Type: Journal Article
• Authors: Christoffersen, Peter; Fournier, Mathieu; Jacobs, Kris
• Is Part Of: Review of financial studies. Volume 31:Number 2(2018)
• Page Start: 595
• Page End: 637
• Publication Date: 2017-08-02
• Subjects: Finance -- United States -- Periodicals; Finance -- Periodicals; 332
• DOI: 10.1093/rfs/hhx089
• Languages: English
• ISSNs: 0893-9454

Abstract

Abstract : Equity options display a strong factor structure. The first principal components of the equity volatility levels, skews, and term structures explain a substantial fraction of the cross-sectional variation. Furthermore, these principal components are highly correlated with the S&P 500 index option volatility, skew, and term structure, respectively. We develop an equity option valuation model that captures this factor structure. The model predicts that firms with higher market betas have higher implied volatilities, steeper moneyness slopes, and a term structure that covaries more with the market. The model provides a good fit, and the equity option data support the model's cross-sectional implications. Received December 20, 2013; editorial decision April 15, 2017 by Editor Leonid Kogan.