The Contribution of Frictions to Expected Returns

95 Pages Posted: 11 Feb 2018 Last revised: 5 Mar 2019

See all articles by Kazuhiro Hiraki

Kazuhiro Hiraki

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

George S. Skiadopoulos

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

Date Written: March 3, 2019

Abstract

We derive a model-free formula to estimate the contribution of market frictions to expected returns (CFER) within a formal asset pricing setting. We document that CFER can be estimated accurately by properly scaled deviations from put-call parity. CFER is sizable, it predicts stock returns and it has superior properties than previously proposed measures of deviations from put-call parity. We find that its predictive power stems from capturing the effect of market frictions, rather than from omitted factors and informed trading. Our findings suggest that market frictions, especially transaction costs, have a sizable effect even on large optionable stocks.

Keywords: Asset pricing, Implied volatility spread, Limits of arbitrage, Market frictions, Put-call parity, Return predictability

JEL Classification: C13, G12, G13

Suggested Citation

Hiraki, Kazuhiro and Skiadopoulos, George, The Contribution of Frictions to Expected Returns (March 3, 2019). Paris December 2018 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=3114764 or http://dx.doi.org/10.2139/ssrn.3114764

Kazuhiro Hiraki (Contact Author)

Queen Mary, University of London, School of Economics and Finance ( email )

Mile End Rd
Mile End Road
London, London E1 4NS
United Kingdom

George Skiadopoulos

University of Piraeus ( email )

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

HOME PAGE: http://web.xrh.unipi.gr/faculty/gskiadopoulos/

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

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

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