Abstract

http://ssrn.com/abstract=1786607
 
 

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Cross-Section of Option Returns and Idiosyncratic Stock Volatility


Jie Cao


Chinese University of Hong Kong - Department of Finance

Bing Han


University of Texas at Austin - McCombs School of Business

July 3, 2012

McCombs Research Paper Series No. FIN-15-09
AFA 2012 Chicago Meetings Paper

Abstract:     
This paper documents a robust new finding that delta-hedged equity option return decreases monotonically with an increase in the idiosyncratic volatility of the underlying stock. This result can not be explained by standard risk factors. It is distinct from existing anomalies in the stock market or volatility-related option mispricing. It is consistent with market imperfections and constrained financial intermediaries. Dealers charge a higher premium for options on high idiosyncratic volatility stocks due to their higher arbitrage costs. Controlling for limits to arbitrage proxies reduces the strength of the negative relation between delta-hedged option return and idiosyncratic volatility by about 40%.

Number of Pages in PDF File: 48

JEL Classification: G12, G13

Accepted Paper Series


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Date posted: March 17, 2011 ; Last revised: November 25, 2012

Suggested Citation

Cao, Jie and Han, Bing, Cross-Section of Option Returns and Idiosyncratic Stock Volatility (July 3, 2012). McCombs Research Paper Series No. FIN-15-09; AFA 2012 Chicago Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1786607

Contact Information

Jie Cao
Chinese University of Hong Kong - Department of Finance ( email )
Room 1242 CYT Building
Shatin, NT
Hong Kong
(852) 3943 7757 (Phone)
(852) 2603 6586 (Fax)
Bing Han (Contact Author)
University of Texas at Austin - McCombs School of Business ( email )
1 University Station - B6600
Austin, TX 78712
United States
(512) 232-6822 (Phone)
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