DescriptionThis dissertation includes three essays on empirical asset pricing as well as the opting pricing theory applied on VIX derivatives. The first essay proposes a new reduced-form model for the pricing of VIX derivatives that includes an independent stochastic jump intensity factor and co-jumps in the level and variance of VIX, while allowing the mean of VIX variance to be time-varying. I fit the model to daily prices of futures and European options from April 2007 through December 2017. The empirical results indicate that the model significantly outperforms all other nested models and improves on benchmark by 21.6% in-sample and 31.2% out-of-sample. The model more accurately portrays the tail behavior of VIX risk-neutral distribution for both short and long maturities, as it better captures the time-varying skew found to be largely independent of the level of the VIX smile.
The second essay proposes a method to estimate relatively high frequent market left- and right-tail risks by constructing trading strategies with daily S&P 500 options. The measures are forward-looking and show low correlations with other risk factors. The essay dissects pricing implications of tail risks for cross-sectional stock returns. Stocks more sensitive to left-tail (right-tail) risk exhibit lower (higher) returns. The right-tail risk premium is significant and partially absorbs the left-tail premium. Results also hold using equity portfolios and mutual funds as test assets. The widespread effect of right-tail risk on assets stands in contrast to previous findings that only negative jumps are priced.
The third essay discovers that investors' preferences for gambling mainly involve stocks that have performed poorly in the past three months, as lottery-like stocks with poor performance are much more likely to generate large payoffs than those with good performance (61.53% vs. 40.17%). Furthermore, lotto investors tend to believe that lottery-like stocks with poor performance may have a vigorous rebound shortly, while those with good performance may be less likely to produce a highly positive return given their high prices. Therefore, lottery-like stocks with poor performance have a highly effective lottery-like look, and thus they attract lotto investors. On the other hand, loser stocks without lottery-like features may continue to perform poorly. Overly optimistic (pessimistic) beliefs about stocks with (without) lottery-like features result in a pronounced lottery premium among loser stocks.