Option-Implied Idiosyncratic and Systematic Risk in the Cross-Section of Expected Stock Returns

52 Pages Posted: 1 Nov 2015 Last revised: 1 Dec 2015

See all articles by Ricardo Lopez Aliouchkin

Ricardo Lopez Aliouchkin

Syracuse University - Whitman School of Management

Date Written: November 17, 2015

Abstract

I introduce a model-based approach to estimate higher order idiosyncratic moments and co-moments (co-skewness and co-kurtosis) of individual equities exclusively from the cross-section of option prices, including the full spectrum of available maturities and strike prices. These estimates are forward-looking and can, thus, be interpreted as truly ex-ante conditional measures of risk. Using standard cross-sectional asset pricing tests, I show that ex-ante moments help explain the cross-section of expected stock returns beyond traditional asset pricing factors, firm characteristics, and ex-post measures of moments. Specifically, I find that idiosyncratic volatility, idiosyncratic skewness and co-skewness are significantly negatively related to expected returns, while co-kurtosis shows a significantly positive relationship. Ex-ante moments are economically significant. A one-standard-deviation increase in idiosyncratic volatility, for example, leads to a 4.44% drop in annual expected returns.

Keywords: Option-implied Risk, Equity Options, Co-skewness, Co-kurtosis

JEL Classification: G12

Suggested Citation

Lopez Aliouchkin, Ricardo, Option-Implied Idiosyncratic and Systematic Risk in the Cross-Section of Expected Stock Returns (November 17, 2015). Swedish House of Finance Research Paper No 15-15 . Available at SSRN: https://ssrn.com/abstract=2683914 or http://dx.doi.org/10.2139/ssrn.2683914

Ricardo Lopez Aliouchkin (Contact Author)

Syracuse University - Whitman School of Management ( email )

721 University Ave
Syracuse, NY NY 13244
United States
+13154433672 (Phone)

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

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