Abstract
Market index and individual stock returns exhibit jumps in addition to normal shocks. Equities have exposure to the market and the sensitivity to market is important for explaining equity returns and option prices. I develop a new factor model that explores (i) if a separate beta for market jumps is needed, (ii) cross-sectional differences in jump betas of stocks, and (iii) the role of jump betas in explaining equity option prices. Differentiating between normal beta and jump beta, the model predicts that a stock with higher sensitivity to market jumps (normal shocks) have higher out-of-the-money (at-the-money) option prices. I estimate the model on a cross-section of S&P500 stocks and a large set of equity options. The results show that market jumps constitute an important part of the total equity premium, jump beta is needed to adequately explain equity returns, market risk exposures, and equity options.
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