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A Bound on Expected Stock Returns

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  • Ohad Kadan
  • Xiaoxiao Tang

Abstract

We present a sufficient condition under which the prices of options written on a particular stock can be aggregated to calculate a lower bound on the expected returns of that stock. The sufficient condition imposes a restriction on a combination of the stock’s systematic and idiosyncratic risk. The lower bound is forward-looking and can be calculated on a high-frequency basis. We estimate the bound empirically and study its cross-sectional properties. We find that the bound increases with beta and book-to-market ratio and decreases with size and momentum. The bound provides an economically meaningful signal about future stock returns.Received July 30, 2017; editorial decision April 18, 2019 by Editor StijnVan Nieuwerburgh. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Suggested Citation

  • Ohad Kadan & Xiaoxiao Tang, 2020. "A Bound on Expected Stock Returns," The Review of Financial Studies, Society for Financial Studies, vol. 33(4), pages 1565-1617.
    • Handle: RePEc:oup:rfinst:v:33:y:2020:i:4:p:1565-1617.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhz075
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    Cited by:

    1. Hui Chen & Antoine Didisheim & Simon Scheidegger, 2021. "Deep Structural Estimation:With an Application to Option Pricing," Cahiers de Recherches Economiques du Département d'économie 21.14, Université de Lausanne, Faculté des HEC, Département d’économie.
    2. Liu, Hong & Tang, Xiaoxiao & Zhou, Guofu, 2022. "Recovering the FOMC risk premium," Journal of Financial Economics, Elsevier, vol. 145(1), pages 45-68.
    3. Cheng Few Lee, 2020. "Financial econometrics, mathematics, statistics, and financial technology: an overall view," Review of Quantitative Finance and Accounting, Springer, vol. 54(4), pages 1529-1578, May.
    4. Wang, Yunqi & Zhou, Ti, 2023. "Out-of-sample equity premium prediction: The role of option-implied constraints," Journal of Empirical Finance, Elsevier, vol. 70(C), pages 199-226.
    5. Fousseni Chabi-Yo & Chukwuma Dim & Grigory Vilkov, 2023. "Generalized Bounds on the Conditional Expected Excess Return on Individual Stocks," Management Science, INFORMS, vol. 69(2), pages 922-939, February.
    6. Hui Chen & Antoine Didisheim & Simon Scheidegger, 2021. "Deep Structural Estimation: With an Application to Option Pricing," Papers 2102.09209, arXiv.org.
    7. Back, Kerry & Crotty, Kevin & Kazempour, Seyed Mohammad, 2022. "Validity, tightness, and forecasting power of risk premium bounds," Journal of Financial Economics, Elsevier, vol. 144(3), pages 732-760.
    8. Karamfil Todorov, 2021. "Passive funds affect prices: evidence from the most ETF-dominated asset classes," BIS Working Papers 952, Bank for International Settlements.

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