On the jump dynamics and jump risk premiums

Abstract

Extreme events, such as market crashes, are important to market participants because they have significant impacts on the welfare of investors. Such events are modeled as jumps in the stochastic processes of asset prices. This paper proposes a semi-parametric approach to examining jump dynamics, and finds that among popular specifications proposed in the literature, the model with an autoregressive jump intensity and a mixture of the exponential and generalized extreme value jump size distribution best characterizes the jump dynamics. The paper also shows that jump risks carry significant premiums, and the jump risk premiums are high when the growths of consumption and production in the economy are low and when the credit risk and volatility are high.