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Option Coskewness and Capital Asset Pricing

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  • Joel M. Vanden

Abstract

This article shows how the market coskewness model of Rubinstein (1973) and Kraus and Litzenberger (1976) is altered when a nonredundant call option is optimally traded. Owing to the option's nonredundancy, the economy's stochastic discount factor (SDF) depends not only on the market return and the square of the market return but also on the option return, the square of the option return, and the product of the market and option returns. This leads to an asset pricing model in which the expected return on any risky asset depends explicitly on the asset's coskewness with option returns. The empirical results show that the option coskewness model outperforms several competing benchmark models. Furthermore, option coskewness captures some of the same risks as the Fama--French factors small minus big (SMB) and high minus low (HML). These results suggest that the factors that drive the pricing of nonredundant options are also important for pricing risky equities.(JEL G11, G12, D61) Copyright 2006, Oxford University Press.

Suggested Citation

  • Joel M. Vanden, 2006. "Option Coskewness and Capital Asset Pricing," The Review of Financial Studies, Society for Financial Studies, vol. 19(4), pages 1279-1320.
    • Handle: RePEc:oup:rfinst:v:19:y:2006:i:4:p:1279-1320
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    File URL: http://hdl.handle.net/10.1093/rfs/hhj030
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    Citations

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    Cited by:

    1. Diavatopoulos, Dean & Doran, James S. & Fodor, Andy & Peterson, David R., 2012. "The information content of implied skewness and kurtosis changes prior to earnings announcements for stock and option returns," Journal of Banking & Finance, Elsevier, vol. 36(3), pages 786-802.
    2. Chan, Kalok & Yang, Jian & Zhou, Yinggang, 2018. "Conditional co-skewness and safe-haven currencies: A regime switching approach," Journal of Empirical Finance, Elsevier, vol. 48(C), pages 58-80.
    3. Johan Knif & Dimitrios Koutmos & Gregory Koutmos, 2020. "Higher Co-Moment CAPM and Hedge Fund Returns," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 48(1), pages 99-113, March.
    4. Delisle, R. Jared & Lee, Bong Soo & Mauck, Nathan, 2012. "The dynamic relation between short sellers, option traders, and aggregate returns," MPRA Paper 42566, University Library of Munich, Germany.
    5. I-Hsuan Ethan Chiang, 2016. "Skewness And Coskewness In Bond Returns," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 39(2), pages 145-178, June.
    6. Almeida, Caio & Garcia, René, 2012. "Assessing misspecified asset pricing models with empirical likelihood estimators," Journal of Econometrics, Elsevier, vol. 170(2), pages 519-537.
    7. Chang, Bo Young & Christoffersen, Peter & Jacobs, Kris, 2013. "Market skewness risk and the cross section of stock returns," Journal of Financial Economics, Elsevier, vol. 107(1), pages 46-68.
    8. Antonio Diez de los Rios & René Garcia, 2011. "The option CAPM and the performance of hedge funds," Review of Derivatives Research, Springer, vol. 14(2), pages 137-167, July.
    9. Potì, Valerio & Wang, DengLi, 2010. "The coskewness puzzle," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1827-1838, August.
    10. Anthonisz, Sean A., 2012. "Asset pricing with partial-moments," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 2122-2135.
    11. Stephan Süss, 2012. "The pricing of idiosyncratic risk: evidence from the implied volatility distribution," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(2), pages 247-267, June.
    12. Cheng, Xin & Chen, Hongyi & Zhou, Yinggang, 2021. "Is the renminbi a safe-haven currency? Evidence from conditional coskewness and cokurtosis," Journal of International Money and Finance, Elsevier, vol. 113(C).
    13. Moreno, David & Rodríguez, Rosa, 2008. "The value of coskewness in evaluating mutual funds," DEE - Working Papers. Business Economics. WB wb087616, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    14. Jian Yang & Yinggang Zhou & Zijun Wang, 2010. "Conditional Coskewness in Stock and Bond Markets: Time-Series Evidence," Management Science, INFORMS, vol. 56(11), pages 2031-2049, November.
    15. Judd, Kenneth L. & Leisen, Dietmar P.J., 2010. "Equilibrium open interest," Journal of Economic Dynamics and Control, Elsevier, vol. 34(12), pages 2578-2600, December.
    16. R. Jared DeLisle & Bong Soo Lee & Nathan Mauck, 2016. "The dynamic relation between options trading, short selling, and aggregate stock returns," Review of Quantitative Finance and Accounting, Springer, vol. 47(3), pages 645-671, October.
    17. Thomas Conlon & John Cotter & Chenglu Jin, 2016. "The Intervaling Effect on Higher-Order Co-Moments," Working Papers 201602, Geary Institute, University College Dublin.
    18. Potì, Valerio, 2018. "A new tight and general bound on return predictability," Economics Letters, Elsevier, vol. 162(C), pages 140-145.
    19. Moreno, David & Rodríguez, Rosa, 2009. "The value of coskewness in mutual fund performance evaluation," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1664-1676, September.
    20. Högholm, Kenneth & Knif, Johan & Koutmos, Gregory & Pynnönen, Seppo, 2011. "Distributional asymmetry of loadings on market co-moments," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(5), pages 851-866.

    More about this item

    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
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis

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