What Does Risk-Neutral Skewness Tell Us About Future Stock Returns?

74 Pages Posted: 28 Mar 2014 Last revised: 3 Nov 2016

See all articles by Przemyslaw Stan Stilger

Przemyslaw Stan Stilger

University of Manchester - Manchester Business School

Alexandros Kostakis

University of Liverpool Management School; University of Manchester - Manchester Business School

Ser-Huang Poon

University of Manchester - Manchester Business School

Date Written: September 15, 2015

Abstract

This study documents a positive relationship between the option-implied risk-neutral skewness (RNS) of individual stock returns' distribution and future realized stock returns during the period 1996-2012. A strategy that is long the quintile portfolio with the highest RNS stocks and short the quintile portfolio with the lowest RNS stocks yields an average Fama-French-Carhart alpha of 55 bps per month (t-stat: 2.47). The significant underperformance of the portfolio with the most negative RNS stocks is driven by those stocks that are also perceived as relatively overpriced according to a series of overvaluation proxies and are too costly or too risky to sell short, thereby hindering the price correction mechanism. Our findings indicate that a highly negative RNS value, when reflecting high hedging demand for options by investors who perceive the underlying stock as relatively overpriced but hard to sell short, is a robust signal of significant future stock underperformance.

Keywords: Option-Implied Information, Risk-Neutral Skewness, Hedging Pressure, Overvaluation, Short Selling Constraints.

Suggested Citation

Stilger, Przemyslaw Stan and Kostakis, Alexandros and Poon, Ser-Huang, What Does Risk-Neutral Skewness Tell Us About Future Stock Returns? (September 15, 2015). Available at SSRN: https://ssrn.com/abstract=2417021 or http://dx.doi.org/10.2139/ssrn.2417021

Przemyslaw Stan Stilger

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Alexandros Kostakis (Contact Author)

University of Liverpool Management School ( email )

Chatham Building
Liverpool, L69 7ZH
United Kingdom

HOME PAGE: http://www.alexkostakis.com

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Ser-Huang Poon

University of Manchester - Manchester Business School ( email )

Crawford House
Oxford Road
Manchester, Manchester M13 9PL
United Kingdom
+44 161 275 4031 (Phone)
+44 161 275 4023 (Fax)

HOME PAGE: http://www.manchester.ac.uk/research/Ser-huang.poon/

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