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The Pricing of Risk-Neutral Systematic Moments in the Cross-Section of Expected Returns

57 Pages Posted: 4 Jan 2011 Last revised: 2 Apr 2011

Jared DeLisle

Utah State University

James Doran

Implied Capital Advisors

David R. Peterson

Florida State University - Department of Finance

Date Written: March 28, 2011

Abstract

This study investigates if changes in risk-neutral systematic volatility, skewness, and kurtosis, are priced, either symmetrically or asymmetrically, as systematic risk factors in the cross-section of stock returns. The moments are constructed using options on the S&P 500, and represent investors' expectation of the distribution of future market returns. Portfolio analyses reveal positive changes in implied market skewness are priced between -5% to -11% annually, while negative changes in implied market skewness are not priced. Additionally, when accounting for an asymmetric relation between returns and implied market skewness, changes in implied market volatility and kurtosis are not priced. The results are robust to portfolio weighting, market capitalization, book-to-market equity ratio, idiosyncratic volatility, and idiosyncratic skewness. Time-series and cross-sectional analyses confirm the portfolio results and associate positive changes in implied market skewness with a negative price of risk. An implied market skewness tracking portfolio possesses a great deal of power to price a variety of portfolio returns, and subsumes other typical hedge portfolios used in asset pricing. The results present a challenge to the theoretical asset pricing models, since the asymmetric results cannot be accounted for in an ICAPM framework, and the pricing of only positive skewness changes is inconsistent with the predictions of prospect theory.

Keywords: asset pricing, risk-neutral moments, systematic volatility, systematic skewness, systematic kurtosis, expected returns

JEL Classification: G10, G11, G12

Suggested Citation

DeLisle, Jared and Doran, James and Peterson, David R., The Pricing of Risk-Neutral Systematic Moments in the Cross-Section of Expected Returns (March 28, 2011). Available at SSRN: https://ssrn.com/abstract=1734520 or http://dx.doi.org/10.2139/ssrn.1734520

Jared DeLisle (Contact Author)

Utah State University ( email )

Logan, UT 84322
United States
435-797-0885 (Phone)

James Doran

Implied Capital Advisors ( email )

1942 Broadway Suite 409
Boulder, CO 80302
United States

David R. Peterson

Florida State University - Department of Finance ( email )

Tallahassee, FL 32306-1042
United States
850-644-8200 (Phone)
850-644-4225 (Fax)

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