Option-Implied Variance Asymmetry and the Cross-Section of Stock Returns

48 Pages Posted: 18 Sep 2017 Last revised: 19 Apr 2018

See all articles by Tao Huang

Tao Huang

Beijing Normal University-Hong Kong Baptist University United International College

Junye Li

Fudan University - School of Management

Date Written: April 2, 2018

Abstract

We find a positive relationship between individual stocks' implied variance asymmetry, defined as the difference between upside and downside risk-neutral semivariances extracted from out-of-money options, and future stock returns. The high-minus-low hedge portfolio earns the excess return of 0.90% (0.67%) per month in equal-weighted (value-weighted) returns. We show that implied variance asymmetry provides a neat measure of risk-neutral skewness and outperforms the standard risk-neutral skewness in predicting the cross-section of future stock returns. Risk-based equilibrium asset pricing models can not explain such a positive relationship, which instead can be potentially explained by information asymmetry and informed trading.

Keywords: Risk-Neutral Semivariances, Implied Variance Asymmetry, Risk-Neutral Skewness, Return Predictability, Informed Trading, Liquidity

JEL Classification: G11, G12, G14

Suggested Citation

Huang, Tao and Li, Junye, Option-Implied Variance Asymmetry and the Cross-Section of Stock Returns (April 2, 2018). Available at SSRN: https://ssrn.com/abstract=3036845 or http://dx.doi.org/10.2139/ssrn.3036845

Tao Huang

Beijing Normal University-Hong Kong Baptist University United International College ( email )

2000 Jintong Road
Zhuhai, Guangdong 519087
China

Junye Li (Contact Author)

Fudan University - School of Management ( email )

No. 670, Guoshun Road
No.670 Guoshun Road
Shanghai, 200433
China

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