Lévy jump risk: Evidence from options and returns

Using index options and returns from 1996 to 2009, I estimate discrete-time models where asset returns follow a Brownian increment and a Lévy jump. Time variations in these models are generated with an affine GARCH, which facilitates the empirical implementation. I find that the risk premium implied by infinite-activity jumps contributes to more than half of the total equity premium and dominates that of the Brownian increments suggesting that it is more representative of the risks present in the economy. Overall, my findings suggest that infinite-activity jumps, instead of the Brownian increments, should be the default modeling choice in asset pricing models.