Risk Neutral Skewness Predicts Price Rebounds and so can Improve Momentum Performance

Abstract

Positive option-implied risk-neutral skewness (RNS) predicts next-month abnormal underlying stock returns driven by upward rebounds of previously undervalued stocks. 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 most negative (positive) RNS. We generalize our findings to non-optionable stocks by constructing an RNS factor-mimicking portfolio, finding that a momentum strategy that avoids performance reversals has meaningfully superior performance. Our results hold after controlling for trading frictions, firm characteristics, and common risk factors.

Keywords: Risk Neutral Skewness, Momentum, Return Predictability

JEL Classification: G12, G13