Tail and volatility indices from option prices. Working paper

Both volatility and the tail of stock return distributions are impacted by discontinuities or large jumps in the stock price process. In this paper, we construct a model-free jump and tail index by measuring the impact of jumps on the Chicago Board Options Exchange’s VIX index. Our jump and tail index is constructed from a portfolio of risk-reversals using 30-day index options, and measures time variations in the intensity of return jumps. Using the index, we document a 50-fold increase in jump fears during the financial crisis, and that jump fears predict index returns after controlling for stock return variability