A Smiling Bear in the Equity Options Market and the Cross-Section of Stock Returns

46 Pages Posted: 20 Jul 2015 Last revised: 19 Oct 2018

See all articles by Hye-hyun Park

Hye-hyun Park

Southwestern University of Finance and Economics (SWUFE)

Baeho Kim

Korea University Business School (KUBS)

Hyeongsop Shim

Gachon University

Date Written: October 16, 2018

Abstract

We propose a measure for the convexity of an option-implied volatility curve, IV convexity, as a forward-looking measure of excess tail-risk contribution to the perceived variance of underlying equity returns. Using equity options data for individual U.S.-listed stocks during 2000-2013, we find that the average return differential between the lowest and highest IV convexity quintile portfolios exceeds 1% per month, which is both economically and statistically significant on a risk-adjusted basis. Our empirical findings indicate the contribution of informed options trading to price discovery in terms of the realization of tail-risk aversion in the stock market.

Keywords: Implied volatility, Convexity, Equity options, Stock returns, Predictability

JEL Classification: G12; G13; G14

Suggested Citation

Park, Hye-hyun and Kim, Baeho and Shim, Hyeongsop, A Smiling Bear in the Equity Options Market and the Cross-Section of Stock Returns (October 16, 2018). Available at SSRN: https://ssrn.com/abstract=2632763 or http://dx.doi.org/10.2139/ssrn.2632763

Hye-hyun Park

Southwestern University of Finance and Economics (SWUFE) ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

Baeho Kim (Contact Author)

Korea University Business School (KUBS) ( email )

Anam-dong, Sungbuk-Gu
Korea University Business School
Seoul, 136-701
82-2-3290-2626 (Phone)
82-2-922-7220 (Fax)

HOME PAGE: http://biz.korea.ac.kr/~baehokim

Hyeongsop Shim

Gachon University ( email )

1342 Seongnamdaero, Sujeong-gu
Gachon-gwan #707
Seongnam-si, 13120
Korea, Republic of (South Korea)
82-31-750-5530 (Phone)

HOME PAGE: http://orcid.org/0000-0001-8722-4610

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