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Option-Implied variance asymmetry and the cross-section of stock returns

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  • Huang, Tao
  • Li, Junye

Abstract

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 options, and future stock returns. The high-minus-low hedge portfolio earns the excess return of 0.90% (0.67%) per month in equal-weighted (value-weighted) returns. We show that implied variance asymmetry provides a neat measure of risk-neutral skewness and outperforms the standard risk-neutral skewness in predicting the cross-section of future stock returns. Risk-based equilibrium asset pricing models can not explain such a positive relationship, which instead can be potentially explained by information asymmetry and informed trading.

Suggested Citation

  • Huang, Tao & Li, Junye, 2019. "Option-Implied variance asymmetry and the cross-section of stock returns," Journal of Banking & Finance, Elsevier, vol. 101(C), pages 21-36.
    • Handle: RePEc:eee:jbfina:v:101:y:2019:i:c:p:21-36
    DOI: 10.1016/j.jbankfin.2019.02.001
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    More about this item

    Keywords

    Risk-neutral semivariances; Implied variance asymmetry; Risk-neutral skewness; Return predictability; Informed trading; Liquidity;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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