What Information Does Risk Neutral Skewness Contain? Evidence From Momentum Crashes

54 Pages Posted: 27 Feb 2018 Last revised: 30 Nov 2018

See all articles by Paul Borochin

Paul Borochin

University of Connecticut - School of Business

Yanhui Zhao

University of Wisconsin - Whitewater - College of Business and Economics

Date Written: November 25, 2018

Abstract

Stocks with high option-implied risk-neutral skewness (RNS) have positive abnormal returns driven by positive reversals following poor performance. This performance reversal also underlies momentum crashes. Consistent with this commonality, the RNS anomaly is strongest in periods of post-recession rebounds when momentum crashes occur. Furthermore, the momentum anomaly is strongest (weakest) in stocks with the lowest (highest) RNS, indicating a positive relationship between RNS and momentum crashes. We generalize our findings to all stocks by constructing an RNS factor-mimicking portfolio and find that a momentum strategy that avoids high skew factor loading stocks, which are more likely to experience positive performance reversals, has superior performance to both the standard and risk-managed momentum strategies. Our results hold after controlling for trading frictions, firm characteristics, and risk factors.

Keywords: Risk Neutral Skewness, Momentum, Return Predictability

JEL Classification: G12, G13

Suggested Citation

Borochin, Paul and Zhao, Yanhui, What Information Does Risk Neutral Skewness Contain? Evidence From Momentum Crashes (November 25, 2018). Available at SSRN: https://ssrn.com/abstract=3125124 or http://dx.doi.org/10.2139/ssrn.3125124

Paul Borochin (Contact Author)

University of Connecticut - School of Business ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States

Yanhui Zhao

University of Wisconsin - Whitewater - College of Business and Economics ( email )

Whitewater, WI 53190
United States

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