Option characteristics as cross-sectional predictors

  • We provide the first comprehensive analysis of option information for pricing the cross-section of stock returns by jointly examining extensive sets of firm and option characteristics. Using portfolio sorts and high-dimensional methods, we show that certain option measures have significant predictive power, even after controlling for firm characteristics, earning a Fama-French three-factor alpha in excess of 20% per annum. Our analysis further reveals that the strongest option characteristics are associated with information about asset mispricing and future tail return realizations. Our findings are consistent with models of informed trading and limits to arbitrage.

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Author:Andreas NeuhierlGND, Xiaoxiao TangGND, Rasmus Tangsgaard VarneskovORCiDGND, Guofu ZhouORCiDGND
Parent Title (English):LawFin working paper ; No. 37
Series (Serial Number):LawFin Working Paper (37)
Publisher:Center for Advanced Studies on the Foundations of Law and Finance, House of Finance, Goethe University
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2022
Year of first Publication:2022
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2022/07/12
Tag:Asset Pricing; Factor Models; High-dimensional Methods; Option-implied Risk
Issue:June 9, 2022
Page Number:59
The paper has benefited significantly from a fellow visit of Andreas Neuhierl at the Center for Advanced Studies Foundations of Law and Finance funded by the German Research Foundation (Deutsche Forschungsgemeinschaft, DFG) - project FOR 2774. Financial support from the Center for Research in Econometric Analysis of Time Series (CRE- ATES) and the Danish Finance Institute (DFI) is gratefully acknowledged.
Institutes:Wissenschaftliche Zentren und koordinierte Programme / DFG-Forschergruppen / Foundation of Law and Finance
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
3 Sozialwissenschaften / 34 Recht / 340 Recht
JEL-Classification:C Mathematical and Quantitative Methods / C1 Econometric and Statistical Methods: General / C13 Estimation
C Mathematical and Quantitative Methods / C1 Econometric and Statistical Methods: General / C14 Semiparametric and Nonparametric Methods
Licence (German):License LogoDeutsches Urheberrecht