Model-Free Implied Dependence and the Cross-Section of Returns

We document the asset-pricing implications of the model-free option-implied dependence (MFID), a measure that exhibits information on linear and non-linear dependence between random variables. We show that stocks with high exposure to MFID generate significantly higher risk-adjusted returns in bad times. This finding is robust when we condition on the exposure to implied correlation and other common risk factors. This suggests that the non-linear component drives the outperformance. Overall, the results are consistent with time-varying preferences, implying increased demand for assets that offer a hedge in bad times.

Keywords: correlation, return predictability, risk premia, comonotonicity

JEL Classification: G11, G12, G13, G14, G15

Suggested Citation: Suggested Citation

Inghelbrecht, Koen and Verdickt, Gertjan and Linders, Daniël and Xie, Yong, Model-Free Implied Dependence and the Cross-Section of Returns (June 1, 2023). Available at SSRN: https://ssrn.com/abstract=4235236 or http://dx.doi.org/10.2139/ssrn.4235236