Equity Options and Firm Characteristics

39 Pages Posted: 31 Jan 2023

See all articles by Gustavo Freire

Gustavo Freire

Erasmus School of Economics; Tinbergen Institute

Onno Kleen

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Tinbergen Institute

Date Written: January 30, 2023

Abstract

We study the relation between a comprehensive set of firm characteristics and the entire universe of individual equity option prices. We find that 42 out of 86 characteristics are priced in the option market, in the sense that they significantly explain differences in the implied volatility surface (IVS) across stocks. Motivated by this finding, we model the IVS of a given stock as a function of its characteristics with a local linear random forest. This approach addresses the illiquidity of the equity option market by effectively grouping similar stocks during estimation. Our method outperforms a stock-specific benchmark model out-of-sample and allows us to uncover the nonlinear interactions between characteristics and option prices.

Keywords: Firm characteristics, Equity options, Implied volatility, Local linear random forest, Pooled estimation

JEL Classification: C58, G12, G13

Suggested Citation

Freire, Gustavo and Kleen, Onno, Equity Options and Firm Characteristics (January 30, 2023). Available at SSRN: https://ssrn.com/abstract=4342597 or http://dx.doi.org/10.2139/ssrn.4342597

Gustavo Freire

Erasmus School of Economics ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Onno Kleen (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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