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An examination of ex ante risk and return in the cross-section using option-implied information

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  • Dongcheol Kim
  • Ren-Raw Chen
  • Tai-Yong Roh
  • Durga Panda

Abstract

This paper examines cross-sectional relations between ex ante expected returns and betas. As a proxy for ex ante expected returns, we use implied returns obtained from the risk-adjusted option pricing model suggested in this paper. We find that implied returns have a positive and significant cross-sectional relation with implied betas in all maturity groups considered. This significant relation is maintained regardless of the inclusion of the well-known CAPM-anomaly variables such as firm size, book-to-market, past returns, earnings-to-price ratio, and liquidity. Ex ante market risk premium estimates have a statistical significance as well as an economic significance in that they contain significant forward-looking information on future macroeconomic conditions. Thus, market betas are priced on an ex ante basis.

Suggested Citation

  • Dongcheol Kim & Ren-Raw Chen & Tai-Yong Roh & Durga Panda, 2020. "An examination of ex ante risk and return in the cross-section using option-implied information," The European Journal of Finance, Taylor & Francis Journals, vol. 26(16), pages 1623-1645, November.
    • Handle: RePEc:taf:eurjfi:v:26:y:2020:i:16:p:1623-1645
    DOI: 10.1080/1351847X.2020.1767171
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