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Informativeness of truncation in the options market

Author

Listed:
  • Lee, Geul
  • Ryu, Doojin
  • Yang, Li

Abstract

Truncation—the absence of deep out-of-the-money option price observations—exhibits significant underlying return predictive and forecasting power. Incorporating truncation into S&P500 spot return models improves both in-sample predictive accuracy and out-of-sample forecasting performance. The close relationship between truncation, underlying returns, and option-implied moments offers a potential explanation for its prediction capabilities. Truncation is not merely noise but contains valuable return-predictive information that may systematically influence the performance of implied moment estimates.

Suggested Citation

  • Lee, Geul & Ryu, Doojin & Yang, Li, 2025. "Informativeness of truncation in the options market," Finance Research Letters, Elsevier, vol. 72(C).
    • Handle: RePEc:eee:finlet:v:72:y:2025:i:c:s1544612324015198
    DOI: 10.1016/j.frl.2024.106490
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    References listed on IDEAS

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    More about this item

    Keywords

    Domain stabilization; Option-implied moments; Return prediction; S&P500 options; Truncation;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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