Treasury option returns and models with unspanned risks

Gurdip Bakshi; John Crosby; Xiaohui Gao; Jorge W. Hansen

doi:10.1016/j.jfineco.2023.103736

Treasury option returns and models with unspanned risks

Gurdip Bakshi^*, John Crosby, Xiaohui Gao, Jorge W. Hansen

^*Corresponding author af dette arbejde

Institut for Økonomi

Publikation: Bidrag til tidsskrift/Konferencebidrag i tidsskrift /Bidrag til avis › Tidsskriftartikel › Forskning › peer review

5 Citationer (Scopus)

Abstract

We document the phenomenon that average excess returns of out-of-the-money puts and calls on bond futures are negative, both unconditionally and conditionally on economic states. To explain these findings, we develop economically motivated restrictions in the context of a theory in which the pricing kernel is a general diffusion process with spanned and unspanned components. Our reconciliation is a framework that introduces market incompleteness and priced unspanned volatility risks, allowing for time-varying downside and upside futures risk premiums. The estimated model shows consistency with data on bond yields, yield volatilities, bond futures return volatilities, option prices, and option risk premiums.

Originalsprog	Engelsk
Artikelnummer	103736
Tidsskrift	Journal of Financial Economics
Vol/bind	150
Nummer	3
Antal sider	30
ISSN	0304-405X
DOI	https://doi.org/10.1016/j.jfineco.2023.103736
Status	Udgivet - dec. 2023

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abstract = "We document the phenomenon that average excess returns of out-of-the-money puts and calls on bond futures are negative, both unconditionally and conditionally on economic states. To explain these findings, we develop economically motivated restrictions in the context of a theory in which the pricing kernel is a general diffusion process with spanned and unspanned components. Our reconciliation is a framework that introduces market incompleteness and priced unspanned volatility risks, allowing for time-varying downside and upside futures risk premiums. The estimated model shows consistency with data on bond yields, yield volatilities, bond futures return volatilities, option prices, and option risk premiums.",

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author = "Gurdip Bakshi and John Crosby and Xiaohui Gao and Hansen, {Jorge W.}",

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AU - Bakshi, Gurdip

AU - Crosby, John

AU - Gao, Xiaohui

AU - Hansen, Jorge W.

PY - 2023/12

Y1 - 2023/12

N2 - We document the phenomenon that average excess returns of out-of-the-money puts and calls on bond futures are negative, both unconditionally and conditionally on economic states. To explain these findings, we develop economically motivated restrictions in the context of a theory in which the pricing kernel is a general diffusion process with spanned and unspanned components. Our reconciliation is a framework that introduces market incompleteness and priced unspanned volatility risks, allowing for time-varying downside and upside futures risk premiums. The estimated model shows consistency with data on bond yields, yield volatilities, bond futures return volatilities, option prices, and option risk premiums.

AB - We document the phenomenon that average excess returns of out-of-the-money puts and calls on bond futures are negative, both unconditionally and conditionally on economic states. To explain these findings, we develop economically motivated restrictions in the context of a theory in which the pricing kernel is a general diffusion process with spanned and unspanned components. Our reconciliation is a framework that introduces market incompleteness and priced unspanned volatility risks, allowing for time-varying downside and upside futures risk premiums. The estimated model shows consistency with data on bond yields, yield volatilities, bond futures return volatilities, option prices, and option risk premiums.

KW - Interest-rate models

KW - Option risk premiums

KW - Options on futures on Treasury bonds

KW - Unspanned risks in the pricing kernel

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DO - 10.1016/j.jfineco.2023.103736

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SN - 0304-405X

VL - 150

JO - Journal of Financial Economics

JF - Journal of Financial Economics

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ER -

Treasury option returns and models with unspanned risks

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