A Bound on Expected Stock Returns
53 Pages Posted: 1 Feb 2018
Date Written: July 1, 2017
We present a sufficient condition under which the prices of options written on a particular stock can be aggregated to calculate a lower bound on the expected returns of that stock. The sufficient condition imposes a restriction on a combination of the stock's systematic and idiosyncratic risk. The lower bound is forward-looking and can be calculated on a high-frequency basis for stocks with liquid option trading. We estimate the lower bound empirically for constituents of the S&P 500 index and study its cross-sectional properties. We find that the bound increases with beta and book-to-market ratio and decreases with size and momentum. The bound also provides an economically meaningful signal on future realized stock returns.
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