RFS Advance Access published online on June 13, 2008
Review of Financial Studies, doi:10.1093/rfs/hhn057
Systematic Risk and the Price Structure of Individual Equity Options
National University of Singapore, and University of Toronto
University of Toronto
Address correspondence to Jason Wei, Joseph L. Rotman School of Management, University of Toronto, Toronto, Canada, M5S 3E6; telephone: 416-978-3687, fax: 416-971-3048; e-mail: wei{at}rotman.utoronto.ca.
JEL Classification: G10, G13
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Abstract |
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This study demonstrates the impact of systematic risk on the prices of individual equity options. The option prices are characterized by the level and slope of implied volatility curves, and the systematic risk is measured as the proportion of systematic variance in the total variance. Using daily option quotes on the S, and P 100 index and its 30 largest component stocks, we show that after controlling for the underlying asset's total risk, a higher amount of systematic risk leads to a higher level of implied volatility and a steeper slope of the implied volatility curve. Thus, systematic risk proportion can help differentiate the price structure across individual equity options.
This paper was previously titled "Is Systematic Risk Pricedin Options?" We are grateful to N. Kapadia, G. Bakshi, and D. Madan for supplying the data set and thank Baha Circi and Jun Zhou for their research assistance. We also thank seminar/conference participants at the CFTC, Institute of Economics of Academia Sinica, Concordia University, HEC Montréal, The Hong Kong University of Science and Technology, McMaster University, Peking University, Queen's University, York University, the 2005 annual meeting of the Northern Finance Association, the 16th Annual Derivatives Securities and Risk Management Conference, the 2006 International Symposium on Financial Engineering and Risk Management, the 2006 Annual Meeting of the China International Conference in Finance, and the 2006 Annual Meeting of the Financial Management Association for their comments. We especially thank Melanie Cao, Raymond Kan, Craig Lewis, Jin Zhang, and an anonymous referee for helpful comments. Both authors acknowledge financial support from the Social Sciences and Humanities Research Council of Canada.