Risk-neutral Skewness, Informed Trading, and the Cross-section of Stock Returns

Journal of Financial and Quantitative Analysis, forthcoming

87 Pages Posted: 1 Oct 2018 Last revised: 30 Mar 2020

See all articles by Tarun Chordia

Tarun Chordia

Emory University - Department of Finance

Tse-Chun Lin

The University of Hong Kong - Faculty of Business and Economics

Vincent Xiang

Deakin University-Department of Finance

Date Written: March 28, 2020

Abstract

This paper uses the volatility surface data from options contracts to document a strong, robust, and positive cross-sectional relation between risk-neutral skewness (RNS) and subsequent stock returns. The differential return between high and low RNS stocks amounts to 0.17% per week. Pre-announcement RNS is positively related to earnings announcement returns, and the positive RNS-return relation is more pronounced for other non-scheduled news releases, suggesting that it is informed trading that drives the positive relation between RNS and returns. We also find that RNS contains incremental information beyond trading signals captured by option implied volatility and volume.

Keywords: Risk-Neutral Skewness, Options Markets, Informed Trading, Earnings Announcements, Non-scheduled News Release

JEL Classification: G12, G14

Suggested Citation

Chordia, Tarun and Lin, Tse-Chun and Xiang, Vincent, Risk-neutral Skewness, Informed Trading, and the Cross-section of Stock Returns (March 28, 2020). Journal of Financial and Quantitative Analysis, forthcoming, Available at SSRN: https://ssrn.com/abstract=3257713 or http://dx.doi.org/10.2139/ssrn.3257713

Tarun Chordia

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States
404-727-1620 (Phone)
404-727-5238 (Fax)

Tse-Chun Lin

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Vincent Xiang (Contact Author)

Deakin University-Department of Finance ( email )

Deakin University
221 Burwood Highway
Burwood, Victoria 3125
Australia

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