Risk Neutral Skewness Predicts Price Rebounds and so can Improve Momentum Performance

59 Pages Posted: 27 Feb 2018 Last revised: 23 Jun 2020

See all articles by Paul Borochin

Paul Borochin

University of Florida - Department of Finance, Insurance and Real Estate

Yanhui Zhao

University of Wisconsin - Whitewater - College of Business and Economics

Date Written: September 8, 2019

Abstract

Positive option-implied risk-neutral skewness (RNS) predicts next-month abnormal underlying stock returns driven by upward rebounds of previously undervalued stocks. The RNS anomaly is strongest in periods of post-recession rebounds when momentum crashes occur. Furthermore, the momentum anomaly is strongest (weakest) in stocks with the most negative (positive) RNS. We generalize our findings to non-optionable stocks by constructing an RNS factor-mimicking portfolio, finding that a momentum strategy that avoids performance reversals has meaningfully superior performance. Our results hold after controlling for trading frictions, firm characteristics, and common risk factors.

Keywords: Risk Neutral Skewness, Momentum, Return Predictability

JEL Classification: G12, G13

Suggested Citation

Borochin, Paul and Zhao, Yanhui, Risk Neutral Skewness Predicts Price Rebounds and so can Improve Momentum Performance (September 8, 2019). Available at SSRN: https://ssrn.com/abstract=3125124 or http://dx.doi.org/10.2139/ssrn.3125124

Paul Borochin (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

Yanhui Zhao

University of Wisconsin - Whitewater - College of Business and Economics ( email )

Whitewater, WI 53190
United States

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