The leverage effect and the basket-index put spread

Jennie Bai, Robert S. Goldstein, Fan Yang

Research output: Contribution to journalArticle

Abstract

Benchmark models that exogenously specify equity dynamics cannot explain the large spread in prices between put options written on individual banks and options written on the bank index during the financial crisis. However, theory requires that asset dynamics be specified exogenously and that endogenously determined equity dynamics exhibit a “leverage effect” that increases put prices by fattening the left tail of the distribution. The leverage effect is larger for puts on individual stocks than for puts on the index, thus increasing the basket-index spread. Time-series and cross-sectional variation in the leverage effect explains option prices well.

Original languageEnglish (US)
Pages (from-to)186-205
Number of pages20
JournalJournal of Financial Economics
Volume131
Issue number1
DOIs
StatePublished - Jan 2019

Keywords

  • Credit spread
  • Leverage effect
  • Option price
  • Volatility

Fingerprint Dive into the research topics of 'The leverage effect and the basket-index put spread'. Together they form a unique fingerprint.

  • Cite this