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A smiling bear in the equity options market and the cross‐section of stock returns
Author(s) -
Park Haehean,
Kim Baeho,
Shim Hyeongsop
Publication year - 2019
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.22000
Subject(s) - convexity , econometrics , economics , equity (law) , financial economics , volatility (finance) , stock (firearms) , mechanical engineering , political science , law , engineering
We propose a measure for the convexity of an option‐implied volatility curve, IV convexity , as a forward‐looking measure of risk‐neutral tail‐risk contribution to the perceived variance of underlying equity returns. Using equity options data for individual US‐listed stocks during 2000–2013, we find that the average realized return differential between the lowest and highest IV convexity quintile portfolios exceeds 1% per month, which is both economically and statistically significant on a risk‐adjusted basis. Our empirical findings indicate the contribution of informed options trading to price discovery in terms of the realization of tail‐risk aversion in the stock market.