The Risk-Neutral Distribution of Option Returns

59 Pages Posted: 22 Jan 2017 Last revised: 26 Feb 2017

See all articles by Turan G. Bali

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business

Nusret Cakici

Fordham University

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management

Scott Murray

Georgia State University

Date Written: January 1, 2017

Abstract

This is the first study on the risk-neutral distribution of option returns. We derive solutions for the risk-neutral variance, skewness, and kurtosis of call and put option returns and document several properties of these ex-ante moments. We find that the volatility, skewness, and kurtosis of both call and put returns are higher (lower) for options that are further out-of-the-money (in-the-money). The risk-neutral moments of call returns are increasing in the volatility of the underlying security, while the opposite is true for put returns. Call return moments have strong negative time-series correlation with put return moments. We find that the magnitudes of the risk-neutral and physical moments differ substantially, indicating significant option volatility, skewness, and kurtosis risk premia. The option volatility risk premium is significantly higher than the stock volatility risk premium.

Keywords: Risk-Neutral Distribution, Option Returns

JEL Classification: G11, G12, G14, G33

Suggested Citation

Bali, Turan G. and Cakici, Nusret and Chabi-Yo, Fousseni and Murray, Scott, The Risk-Neutral Distribution of Option Returns (January 1, 2017). Georgetown McDonough School of Business Research Paper No. 2902209. Available at SSRN: https://ssrn.com/abstract=2902209 or http://dx.doi.org/10.2139/ssrn.2902209

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: https://sites.google.com/a/georgetown.edu/turan-bali

Nusret Cakici

Fordham University ( email )

Fordham University
Graduate School of Business
New York, NY 10023
United States
2126366776 (Phone)

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

Scott Murray (Contact Author)

Georgia State University ( email )

35 Broad Street
Atlanta, GA 30303-3083
United States

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