An Examination of Ex Ante Risk and Return in the Cross-Section Using Option-Implied Information

Forthcoming, European Journal of Finance.

44 Pages Posted: 24 Jun 2020 Last revised: 7 Jan 2021

See all articles by Dongcheol Kim

Dongcheol Kim

Korea University Business School

Ren-Raw Chen

affiliation not provided to SSRN

Tai-Yong Roh

Liaoning University

Durga Panda

Fordham University

Date Written: April 1, 2020

Abstract

This paper examines cross-sectional relations between ex ante expected returns and betas. As a proxy for ex ante expected returns, we use implied returns obtained from the risk-adjusted option pricing model suggested in this paper. We find that implied returns have a positive and significant cross-sectional relation with implied betas in all maturity groups considered. This significant relation is maintained regardless of the inclusion of the well-known CAPM-anomaly variables such as firm size, book-to-market, past returns, earnings-to-price ratio, and liquidity. Ex ante market risk premium estimates have a statistical significance as well as an economic significance in that they contain significant forward-looking information on future macroeconomic conditions. Thus, market betas are priced on an ex ante basis.

Keywords: Option-implied return, Option-implied beta, Risk-adjusted option pricing model, Cross-section of expected returns, Macroeconomic condition

JEL Classification: G12, G13, G14

Suggested Citation

Kim, Dongcheol and Chen, Ren-Raw and Roh, Tai-Yong and Panda, Durga, An Examination of Ex Ante Risk and Return in the Cross-Section Using Option-Implied Information (April 1, 2020). Forthcoming, European Journal of Finance., Available at SSRN: https://ssrn.com/abstract=3616619

Dongcheol Kim

Korea University Business School ( email )

Anam-Dong, Seongbuk-Gu
Seoul 136-701, 136701
Korea
+82-2-3290-2606 (Phone)

Ren-Raw Chen

affiliation not provided to SSRN

Tai-Yong Roh (Contact Author)

Liaoning University ( email )

Shenyang, Liaoning
China

Durga Panda

Fordham University ( email )

113 West 60th Street
New York, NY 10023
United States

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