The Contribution of Frictions to Expected Returns: An Options-based Estimation Approach

68 Pages Posted: 11 Feb 2018 Last revised: 16 Feb 2021

See all articles by Kazuhiro Hiraki

Kazuhiro Hiraki

Bank of Japan

George S. Skiadopoulos

University of Piraeus, Department of Banking and Financial Management; Queen Mary, University of London, School of Economics and Finance

Date Written: Feburary 11, 2021

Abstract

We document that properly scaled deviations from put-call parity estimate the contribution of market frictions to expected returns (CFER) accurately, by means of a non-parametric theoretically founded identification strategy. The required conditions are that our estimator predicts the underlying but not the synthetic stock's return. The data satisfy the two conditions; the alphas of the estimated CFER-sorted spread portfolios are up to 1.86% per month. The estimated CFER covaries non-linearly with proxies of market frictions. An agent-based equilibrium model explains our findings; alphas can be twice as big as the round-trip transaction costs, thus corroborating the accuracy of our estimator.

Keywords: Limits to arbitrage, Market frictions, Put-call parity, Return predictability

JEL Classification: C13, G10, G12, G13

Suggested Citation

Hiraki, Kazuhiro and Skiadopoulos, George and Skiadopoulos, George, The Contribution of Frictions to Expected Returns: An Options-based Estimation Approach (Feburary 11, 2021). Available at SSRN: https://ssrn.com/abstract=3114764 or http://dx.doi.org/10.2139/ssrn.3114764

Kazuhiro Hiraki (Contact Author)

Bank of Japan ( email )

2-1-1, Nihonbashi-hongokucho
Chuo-ku, Tokyo 103-0021
Japan

George Skiadopoulos

Queen Mary, University of London, School of Economics and Finance

Lincoln's Inn Fields
Mile End Rd.
London, E1 4NS
United Kingdom

University of Piraeus, Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

HOME PAGE: http://https://sites.google.com/view/george-skiadopoulos

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