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Market Returns Dormant in Options Panels

Author

Listed:
  • Yoosoon Chang

    (Indiana University, Department of Economics)

  • Youngmin Choi

    (Baruch College (CUNY), Zicklin School of Business, Department of Economics and Finance)

  • Soohun Kim

    (Korea Advanced Institute of Science and Technology (KAIST), College of Business)

  • Joon Park

    (Indiana University, Department of Economics)

Abstract

This paper develops a novel functional predictive regression framework linking option-implied distributions to stock market returns, motivated by the fundamental link between risk-neutral and physical densities. Using extensive S&P 500 option panels, our model exhibits significant forecasting power, achieving robust out-of-sample R2 exceeding 4% and outperforming traditional predictors. Superior performance arises from leveraging the full spectrum of the risk-neutral density via functional principal components. Our analysis reveals forecasting success stems from nuanced variations in risk-neutral densities beyond conventional finite moments, underscoring the predictive value of distributional shape and higher-order information, and demonstrates potential economic gains through a market-timing strategy.

Suggested Citation

  • Yoosoon Chang & Youngmin Choi & Soohun Kim & Joon Park, 2025. "Market Returns Dormant in Options Panels," CAEPR Working Papers 2025-003 Classification- , Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    • Handle: RePEc:inu:caeprp:2025003
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