Option Valuation with Business Conditions and Skewness

This paper exploits business conditions and skewness to improve option pricing. We construct a user-friendly affine framework that incorporates the observable model-free macroeconomic variables and latent skewed innovations, and this new configuration nests and outperforms a wide range of empirically well-tested models. To facilitate practical implementations, we obtain closed-form formulas for pricing SPX options under a variance-dependent kernel. Several sets of empirical studies over the 2008 Great Recession and the ongoing COVID-19 recession demonstrate significant and robust improvements in option pricing brought about by macroeconomic variables, and we find that these improvements are enhanced by the introduction of innovation skewness.