Model-Free Implied Dependence and the Cross-Section of Returns
80 Pages Posted: 4 Oct 2022 Last revised: 2 Jun 2023
Date Written: June 1, 2023
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
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