Opacity, Crash Risk, and the Option Smirk Curve

41 Pages Posted: 17 Jul 2010 Last revised: 9 Aug 2010

See all articles by Mark T Bradshaw

Mark T Bradshaw

Boston College

Amy P. Hutton

Boston College - Carroll School of Management

Alan J. Marcus

Boston College - Department of Finance

Hassan Tehranian

Boston College - Department of Finance

Date Written: July 15, 2010

Abstract

We investigate three facets of cross-sectional variation in the risk of stock price crashes: actual crash incidence, and two predictors of that risk, accounting opacity and the option smirk curve. We show that all three of these variables are related. Option smirks and accounting opacity each independently predict cross-sectional variation in crash risk and crash magnitude. The slope of the smirk curve and opacity are themselves correlated at extremely high levels of statistical significance, indicating that the market is aware of the link between opacity and crash risk. Nevertheless, even controlling for the option smirk, several measures of accounting opacity continue to be reliably associated with crash risk, suggesting that the options market does not fully utilize the predictive value of accounting opacity. Moreover, some of our results are consistent with behavioral models in which strong recent performance is extrapolated too far into the future, only to result in a major reversal when those expectations are disappointed.

Keywords: option pricing, earnings management, crash risk, transparency, opacity, smirk

JEL Classification: G19, D89, M40

Suggested Citation

Bradshaw, Mark T and Hutton, Amy P. and Marcus, Alan J. and Tehranian, Hassan, Opacity, Crash Risk, and the Option Smirk Curve (July 15, 2010). Available at SSRN: https://ssrn.com/abstract=1640733 or http://dx.doi.org/10.2139/ssrn.1640733

Mark T Bradshaw

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Amy P. Hutton (Contact Author)

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
617 552 1951 (Phone)

Alan J. Marcus

Boston College - Department of Finance ( email )

Fulton Hall
Chestnut Hill, MA 02467
United States
617-552-2767 (Phone)
617-552-0431 (Fax)

Hassan Tehranian

Boston College - Department of Finance ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States
617-552-3944 (Phone)
617-552-0431 (Fax)

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