Pricing Event Risk: Evidence from Concave Implied Volatility Curves

45 Pages Posted: 7 May 2021

See all articles by Lykourgos Alexiou

Lykourgos Alexiou

Athens University of Economics and Business

Amit Goyal

University of Lausanne; Swiss Finance Institute

Alexandros Kostakis

University of Liverpool Management School; University of Manchester - Manchester Business School

Leonidas Rompolis

Athens University of Economics and Business - Department of Accounting and Finance

Date Written: April 20, 2021

Abstract

We document that implied volatility (IV) curves extracted from short-term equity options frequently become concave prior to the earnings announcement day (EAD) reflecting a bimodal risk-neutral distribution for the underlying stock price. Firms with concave IV curves exhibit significantly higher absolute stock returns on EAD and higher realized volatility after the announcement, as compared to firms with non-concave IV curves. Hence, concavity in the IV curve constitutes an ex-ante option-based signal for event risk in the underlying stock. Returns on delta-neutral straddles around EADs are significantly lower in the presence of concave IV curves, showing that investors pay a high premium to hedge against this event risk.

Keywords: Earnings Announcement, Event Risk, Risk-Neutral Distribution, Implied Volatility Curve

Suggested Citation

Alexiou, Lykourgos and Goyal, Amit and Kostakis, Alexandros and Rompolis, Leonidas, Pricing Event Risk: Evidence from Concave Implied Volatility Curves (April 20, 2021). Available at SSRN: https://ssrn.com/abstract=3840081

Lykourgos Alexiou

Athens University of Economics and Business ( email )

76 Patission Street
Athens, 104 34
Greece

Amit Goyal (Contact Author)

University of Lausanne ( email )

Batiment Extranef 226
Lausanne, Vaud CH-1015
Switzerland
+41 21 692 3676 (Phone)
+41 21 692 3435 (Fax)

HOME PAGE: http://www.hec.unil.ch/agoyal/

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Alexandros Kostakis

University of Liverpool Management School ( email )

Chatham Building
Liverpool, L69 7ZH
United Kingdom

HOME PAGE: http://www.alexkostakis.com

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Leonidas Rompolis

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece

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