The Contribution of Frictions to Expected Returns

83 Pages Posted: 11 Feb 2018 Last revised: 10 Mar 2020

See all articles by Kazuhiro Hiraki

Kazuhiro Hiraki

Bank of Japan

George S. Skiadopoulos

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

Date Written: March 10, 2020


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 properly scaled deviations from put-call parity estimate CFER accurately. We show theoretically that CFER is non-linearly related to the size of frictions, its return predictability becomes stronger over stocks subject to greater frictions, and the alpha of CFER-sorted spread portfolios can be as big as twice the round-trip transaction costs. We empirically validate these theoretical predictions, thus justifying the sizable CFER and the alphas of CFER-sorted spread portfolios, which we find among optionable stocks. Our analysis provides a friction-based theoretical explanation to previous evidence about the return predictability of deviations from put-call parity. In contrast to CFER, the relation of other measures of deviations from put-call parity with expected returns, the empirically estimated alphas and the strength of predictability cannot be established theoretically.

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

JEL Classification: C13, G10, G12, G13

Suggested Citation

Hiraki, Kazuhiro and Skiadopoulos, George, The Contribution of Frictions to Expected Returns (March 10, 2020). Paris December 2018 Finance Meeting EUROFIDAI - AFFI, Available at SSRN: or

Kazuhiro Hiraki (Contact Author)

Bank of Japan ( email )

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

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 ( email )

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


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