Equilibrium asset and option pricing under jump diffusion

This paper develops an equilibrium asset and option pricing model in a production economy under jump diiffusion. The model provides analytical formulas for an equity premium and a more general pricing kernel that links the physical and risk-neutral densities. The model explains the two empirical phenomena of the negative variance risk premium and implied volatility smirk if market crashes are expected. Model estimation with the S&P 500 index from 1985 to 2005 shows that jump size is indeed negative and the risk aversion coe±cient has a reasonable value when taking the jump into account. This is a joint work with Huimin Zhao and Eric C. Chang.postprin