Market Returns Dormant in Options Panels

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.