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Predictable Dynamics in Higher Order Risk-Neutral Moments: Evidence from the S&P 500 Options

49 Pages Posted: 31 Dec 2010 Last revised: 12 Mar 2012

Michael Neumann

Bank of America - Bank of America Merrill Lynch

George S. Skiadopoulos

University of Piraeus; Queen Mary, University of London, School of Economics and Finance

Multiple version iconThere are 2 versions of this paper

Date Written: March 10, 2012

Abstract

We investigate whether there are predictable patterns in the dynamics of higher order risk-neutral moments extracted from the market prices of S&P 500 index options. To this end, we conduct a horse race among alternative forecasting models within an out-of-sample context over various forecasting horizons. We consider both a statistical and an economic setting. We find that higher risk-neutral moments can be statistically forecasted. However, only the one-day-ahead skewness forecasts can be economically exploited. This economic significance vanishes once we incorporate transaction costs. The results have implications for the dynamics of implied volatility surfaces.

Keywords: Implied volatility surface, Market efficiency, Model confidence set, Option strategies, Risk-neutral skewness, Risk-neutral kurtosis

JEL Classification: C53, C58, G10, G13, G17

Suggested Citation

Neumann, Michael and Skiadopoulos, George S., Predictable Dynamics in Higher Order Risk-Neutral Moments: Evidence from the S&P 500 Options (March 10, 2012). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1732640 or http://dx.doi.org/10.2139/ssrn.1732640

Michael Neumann

Bank of America - Bank of America Merrill Lynch ( email )

United States

George Skiadopoulos (Contact Author)

University of Piraeus ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

HOME PAGE: http://web.xrh.unipi.gr/faculty/gskiadopoulos/

Queen Mary, University of London, School of Economics and Finance

Lincoln's Inn Fields
Mile End Rd.
London, E1 4NS
United Kingdom

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