Abstract
This study empirically investigates whether macroeconomic factors are priced in the cross-section of index option returns. Macroeconomic factors are extracted from a large panel of 132 economic activity indicators using dynamic factor analysis. The empirical analysis employs linear factor methodology with a factor structure including market return and macroeconomic factors. The results show that the risk premia on inflation, term spread, industrial production, and housing factors are significant. Further, business sales is a useful conditioning factor that drives variation in market betas. These extracted macroeconomic factors provide information that is not fully captured by Fama and French's (2015) investment and profitability factors.
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