Consumption risks in option returns

Abstract

We offer evidence that exposures to consumption growth and consumption volatility are significantly priced in the cross-section of delta-hedged option returns. Consumption growth commands a positive risk premium, whereas consumption volatility commands a negative risk premium. Our results suggest that consumption risk exposures provide rational foundations for well-known relations between options moneyness or idiosyncratic underlying-stock volatility and the cross-section of delta-hedged option returns. Furthermore, those risk premiums can also price stocks. In a representative-agent economy with recursive preferences, our results suggest that investors prefer early resolution of uncertainty. • Exposures to consumption growth and volatility are priced in option returns. • Consumption risk exposures explain well-known relations in the option market. • Consumption growth and volatility premiums are positive and negative respectively. • Option consumption risk premiums can also price stocks. • Empirical results show that investors prefer early resolution of uncertainty.