Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options

49 Pages Posted: 20 Sep 2001

See all articles by Gurdip Bakshi

Gurdip Bakshi

Fox School of Business

Nikunj Kapadia

University of Massachusetts Amherst - Department of Finance

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business

Date Written: July 2, 2001

Abstract

This article provides several new insights into the economic sources of skewness. First, we document the differential pricing of individual equity options versus the market index, and relate it to variations in return skewness. Second, we show how risk aversion introduces skewness in the risk-neutral density. Third, we derive laws that decompose individual return skewness into a systematic component and an idiosyncratic component. Empirical analysis of OEX options and 30 stocks demonstrates that individual risk-neutral distributions differ from that of the market index by being far less negatively skewed. This paper explains the presence and evolution of risk-neutral skewness over time and in the cross-section of individual stocks.

JEL Classification: G10, G11, G12

Suggested Citation

Bakshi, Gurdip S. and Kapadia, Nikunj and Madan, Dilip B., Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options (July 2, 2001). Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=282451 or http://dx.doi.org/10.2139/ssrn.282451

Gurdip S. Bakshi (Contact Author)

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Nikunj Kapadia

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States
413-545-5643 (Phone)
413-545-5600 (Fax)

HOME PAGE: http://www-unix.oit.umass.edu/~nkapadia/

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2127 (Phone)
301-314-9157 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
801
Abstract Views
5,732
rank
29,325
PlumX Metrics