Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options

@article{Kapadia2000StockRC,
  title={Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options},
  author={Nikunj Kapadia and Gurdip Bakshi and Dilip B. Madan},
  journal={Journal of Financial Abstracts eJournal},
  year={2000}
}
This article provides several new insights into the economic sources of skewness. First, we document the differential pricing of individual equity options versus the market index, and relate it to variations in return skewness. Second, we show how risk aversion introduces skewness in the risk-neutral density. Third, we derive laws that decompose individual return skewness into a systematic component and an idiosyncratic component. Empirical analysis of OEX options and 30 stocks demonstrates… 

Does Risk-Neutral Skewness Predict the Cross-Section of Equity Option Portfolio Returns?

Abstract We investigate the pricing of risk-neutral skewness in the stock options market by creating skewness assets comprised of two option positions (one long and one short) and a position in the

Market Skewness Risk and the Cross-Section of Stock Returns

The cross section of stock returns has substantial exposure to risk captured by higher moments of market returns. We estimate these moments from daily Standard & Poor's 500 index option data. The

Skewness Swaps: Evidence from the Cross-Section of Stocks

This paper studies the skewness risk premia in individual stocks using skewness swaps. Skewness swaps are trading strategies in which an investor buys the stock's risk-neutral skewness and receives

Option-Implied Variance Asymmetry and the Cross-Section of Stock Returns

We find a positive relationship between individual stocks’ implied variance asymmetry, defined as the difference between upside and downside risk-neutral semivariances extracted from out-of-money

Real Options, Idiosyncratic Skewness, and Diversification

We show how firm-level real options lead to idiosyncratic skewness in stock returns. We then document empirically that growth option variables are positive and significant determinants of

Asymmetric Variance Premium, Skewness Premium, and the Cross-Section of Stock Returns

We find a positive relationship between the individual stocks’ asymmetric variance premia, defined as the difference between the risk-neutral and physical expected variance asymmetries, and the

Implications of Asymmetry Risk for Portfolio Analysis and Asset Pricing

Asymmetric shocks are common in markets; securities' payoffs are not normally distributed and exhibit skewness. This paper studies the portfolio holdings of heterogeneous agents with preferences over

Does Skewness Matter? Evidence from the Index Options Market

Current research on stock returns indicates that neglecting conditional skewness may bias inferences about risk. In this paper, we examine if time-varying skewness in asset returns explains option

Cross-sectional Variation of Option Implied Volatility Skew

The slope of the option implied volatility plot against the strike reflects the risk-neutral skewness of the underlying security's conditional return distribution. We identify two principal risk

Risk-Neutral Skewness: Evidence from Stock Options

We investigate the relative importance of various factors in explaining the volatility skew observed in the prices of stock options traded on the Chicago Board Options Exchange. The skewness of the
...

References

SHOWING 1-10 OF 68 REFERENCES

Conditional Skewness in Asset Pricing Tests

If asset returns have systematic skewness, expected returns should include rewards for accepting this risk. We formalize this intuition with an asset pricing model that incorporates conditional

Risk, Return, and Equilibrium: Empirical Tests

This paper tests the relationship between average return and risk for New York Stock Exchange common stocks. The theoretical basis of the tests is the "two-parameter" portfolio model and models of

Options on Leveraged Equity: Theory and Empirical Tests

We develop an option pricing model for calls and puts written on leveraged equity in an economy with corporate taxes and bankruptcy costs. The model explains implied Black-Scholes volatility biases

Option Pricing and the Martingale Restriction

In the absence of frictions, the value of the underlying asset implied by option prices must equal its actual market value. With frictions, however, this requirement need not hold. Using S&P 100

Option Prices with Uncertain Fundamentals: Theory and Evidence on the Dynamics of Implied Volatilities

In an incomplete information model, investors' uncertainty about the underlying drift rate of a firm's fundamentals affects option prices through (i) endogenous and belief-dependent stochastic

Option Valuation with Systematic Stochastic Volatility

The authors use an extension of the equilibrium framework of M. Rubinstein (1976) and M. Brennan (1979) to derive an option valuation formula when the stock return volatility is both stochastic and

How Much Do Expected Stock Returns Vary Over Time? Answers From the Options Markets

This paper makes indirect inference about the time-variation in expected stock returns by comparing unconditional sample variances to estimates of expected conditional variances. The evidence reveals

Integrated Time-Series Analysis of Spot and Option Prices

This paper examines the joint time series of the S&P 500 index and near-the-money short-dated option prices with an arbitrage-free model, capturing both stochastic volatility and jumps. Jump-risk
...