Using data on individual stock options, we show that the currently observed option-implied ex ante skewness is positively related to future stock returns. This contrasts with the existing evidence that uses historical stock or option data to estimate skewness and finds a negative skewness-return relation. We proxy for the ex ante skewness by using the model-free implied skewness (MFIS) and show that high MFIS stocks outperform low MFIS stocks by 45 basis points per month after correcting for systematic exposure. We find that the positive MFIS-return relation stems from the ability of the current MFIS to identify the deviation of a firm’s value from its fundamental value, and the most overvalued stocks have the most negative ex ante skewness. We further find that the speed of the value correction process depends on the arbitrage risk faced by arbitrageurs trying to exploit the observed inefficiencies. Our results have implications for the segmentation of equity and options markets as well as for limits of arbitrage in equity markets.
{"title":"Risk-Neutral Skewness: Return Predictability and Its Sources","authors":"Zahid Rehman, G. Vilkov","doi":"10.2139/ssrn.1301648","DOIUrl":"https://doi.org/10.2139/ssrn.1301648","url":null,"abstract":"Using data on individual stock options, we show that the currently observed option-implied ex ante skewness is positively related to future stock returns. This contrasts with the existing evidence that uses historical stock or option data to estimate skewness and finds a negative skewness-return relation. We proxy for the ex ante skewness by using the model-free implied skewness (MFIS) and show that high MFIS stocks outperform low MFIS stocks by 45 basis points per month after correcting for systematic exposure. We find that the positive MFIS-return relation stems from the ability of the current MFIS to identify the deviation of a firm’s value from its fundamental value, and the most overvalued stocks have the most negative ex ante skewness. We further find that the speed of the value correction process depends on the arbitrage risk faced by arbitrageurs trying to exploit the observed inefficiencies. Our results have implications for the segmentation of equity and options markets as well as for limits of arbitrage in equity markets.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"1 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2012-03-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"79003563","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper develops a new family of Bayesian semiparametric models. A particular member of this family is used to model option prices with the aim of improving out-of-sample predictions. A detailed empirical analysis is made for European index call and put options to illustrate the ideas.
{"title":"A New Class of Bayesian Semiparametric Models with Applications to Option Pricing","authors":"Marcin T. Kacperczyk, P. Damien, S. Walker","doi":"10.2139/ssrn.416583","DOIUrl":"https://doi.org/10.2139/ssrn.416583","url":null,"abstract":"This paper develops a new family of Bayesian semiparametric models. A particular member of this family is used to model option prices with the aim of improving out-of-sample predictions. A detailed empirical analysis is made for European index call and put options to illustrate the ideas.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"84 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2011-04-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"80672633","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this paper I examine the market price of risk of the variance term structure. To this end, the S&P 500 option implied variance term structure is used as a proxy for aggregate variance risk. Principal component analysis shows that time variation in the variance term structure over the 1996–2012 period can be explained mainly by two factors which capture changes in the level and slope. The market price of risk of each factor is estimated in the cross-section of stock returns. The slope of the variance term structure is the most significant factor in the cross-section of stocks returns and carries a negative risk premium. The slope factor has also some predictive ability over long horizon equity returns.
{"title":"The Market Price of Risk of the Variance Term Structure","authors":"George Dotsis","doi":"10.2139/ssrn.1469585","DOIUrl":"https://doi.org/10.2139/ssrn.1469585","url":null,"abstract":"In this paper I examine the market price of risk of the variance term structure. To this end, the S&P 500 option implied variance term structure is used as a proxy for aggregate variance risk. Principal component analysis shows that time variation in the variance term structure over the 1996–2012 period can be explained mainly by two factors which capture changes in the level and slope. The market price of risk of each factor is estimated in the cross-section of stock returns. The slope of the variance term structure is the most significant factor in the cross-section of stocks returns and carries a negative risk premium. The slope factor has also some predictive ability over long horizon equity returns.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"160 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2011-04-05","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"72652424","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
type="main"> We find that stocks with higher levels of prelisting short activity have a greater probability of option listing. These results are driven by the prelisting short activity of market makers, which suggests that exchanges believe that stocks with greater short selling will provide option market makers a better opportunity to hedge with short sales in the spot market. We also confirm that after options are listed, stocks with more prelisting short activity have more option trading activity. These results indicate that option exchanges strategically list options for stocks they believe with generate high trading volume thereby maximizing the profits of exchange members.
{"title":"Short Sales and Option Listing Decisions","authors":"Benjamin M. Blau, Tyler Brough","doi":"10.2139/ssrn.1260354","DOIUrl":"https://doi.org/10.2139/ssrn.1260354","url":null,"abstract":"type=\"main\"> We find that stocks with higher levels of prelisting short activity have a greater probability of option listing. These results are driven by the prelisting short activity of market makers, which suggests that exchanges believe that stocks with greater short selling will provide option market makers a better opportunity to hedge with short sales in the spot market. We also confirm that after options are listed, stocks with more prelisting short activity have more option trading activity. These results indicate that option exchanges strategically list options for stocks they believe with generate high trading volume thereby maximizing the profits of exchange members.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"37 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2011-03-02","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"79753488","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Alexandros Kostakis, Nikolaos Panigirtzoglou, G. Skiadopoulos
We address the empirical implementation of the static asset allocation problem by developing a forward-looking approach that uses information from market option prices. To this end, we extract constant maturity S&P 500 implied distributions and transform them to the corresponding risk-adjusted ones. Then we form optimal portfolios consisting of a risky and a risk-free asset and evaluate their out-of-sample performance. We find that the use of risk-adjusted implied distributions times the market and makes the investor better off than if she uses historical returns' distributions to calculate her optimal strategy. The results hold under a number of evaluation metrics and utility functions and carry through even when transaction costs are taken into account. Not surprisingly, the reported market timing ability deteriorated during the recent subprime crisis. An extension of the approach to a dynamic asset allocation setting is also presented. This paper was accepted by Wei Xiong, finance.
{"title":"Market Timing with Option-Implied Distributions: A Forward-Looking Approach","authors":"Alexandros Kostakis, Nikolaos Panigirtzoglou, G. Skiadopoulos","doi":"10.2139/ssrn.1288103","DOIUrl":"https://doi.org/10.2139/ssrn.1288103","url":null,"abstract":"We address the empirical implementation of the static asset allocation problem by developing a forward-looking approach that uses information from market option prices. To this end, we extract constant maturity S&P 500 implied distributions and transform them to the corresponding risk-adjusted ones. Then we form optimal portfolios consisting of a risky and a risk-free asset and evaluate their out-of-sample performance. We find that the use of risk-adjusted implied distributions times the market and makes the investor better off than if she uses historical returns' distributions to calculate her optimal strategy. The results hold under a number of evaluation metrics and utility functions and carry through even when transaction costs are taken into account. Not surprisingly, the reported market timing ability deteriorated during the recent subprime crisis. An extension of the approach to a dynamic asset allocation setting is also presented. \u0000 \u0000This paper was accepted by Wei Xiong, finance.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"77 1 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2011-02-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"83385517","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper gives a new taxonomy of dynamic term structure models that classifies all existing TSMs as either fundamental models or preference-free single-plus, double-plus, and triple-plus models. We exemplify the new taxonomy by considering preference-free versions of some well-known fundamental short rate models. Single-plus extensions of the fundamental models are shown to be both time-homogeneous and preference-free - two characteristics which do not simultaneously hold under any existing class of TSMs. Though the analytical apparatus for pricing fixed income securities is identical under fundamental models and single-plus models, the latter models are consistent with general non-linear forms of MPRs which may also depend upon an arbitrary set of state variables, leading to better estimates of risk-neutral parameters. The preference-free double-plus and triple-plus extensions of the fundamental models are similar to the Heath, Jarrow, and Morton [1992] models, in that time-inhomogeneous drifts and volatilities are used as "smoothing variables" to fit the initial bond prices and initial term structure of volatilities, respectively.
{"title":"A New Taxonomy of the Dynamic Term Structure Models","authors":"Sanjay K. Nawalkha, N. Beliaeva, G. M. Soto","doi":"10.2139/ssrn.1265286","DOIUrl":"https://doi.org/10.2139/ssrn.1265286","url":null,"abstract":"This paper gives a new taxonomy of dynamic term structure models that classifies all existing TSMs as either fundamental models or preference-free single-plus, double-plus, and triple-plus models. We exemplify the new taxonomy by considering preference-free versions of some well-known fundamental short rate models. Single-plus extensions of the fundamental models are shown to be both time-homogeneous and preference-free - two characteristics which do not simultaneously hold under any existing class of TSMs. Though the analytical apparatus for pricing fixed income securities is identical under fundamental models and single-plus models, the latter models are consistent with general non-linear forms of MPRs which may also depend upon an arbitrary set of state variables, leading to better estimates of risk-neutral parameters. The preference-free double-plus and triple-plus extensions of the fundamental models are similar to the Heath, Jarrow, and Morton [1992] models, in that time-inhomogeneous drifts and volatilities are used as \"smoothing variables\" to fit the initial bond prices and initial term structure of volatilities, respectively.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"24 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2010-09-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"83832804","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The lognormal diffusion process is mathematically tractable and incorporates the kind of continuous random evolution of the price by small increments that seems to characterize most security prices. But market microstructure studies have shown that a lognormal diffusion does not describe very well price formation at the shortest intervals. This is especially true of short-term bond returns. Bond price changes are mostly small, but the tails of the distribution are fatter than the lognormal allows and occasional non-diffusive jumps do seem to occur. Also, the intervals between price changes vary considerably in length. Alternative distributions have been proposed, but they do not have the convenient mathematical properties of the lognormal, so implementation can be challenging. Hainaut and MacGilchrist propose using the normal inverse Gaussian (NIG) distribution that arises from a particular Levy process and develop a lattice implementation for pricing. A pentanomial tree incorporates the NIG by matching its first four moments. In a simulation exercise, the NIG consistently outperforms the lognormal, largely due to its ability to capture skewness in returns.
{"title":"An Interest Rate Tree Driven by a Lévy Process","authors":"Donatien Hainaut, R. Macgilchrist","doi":"10.2139/SSRN.2324170","DOIUrl":"https://doi.org/10.2139/SSRN.2324170","url":null,"abstract":"The lognormal diffusion process is mathematically tractable and incorporates the kind of continuous random evolution of the price by small increments that seems to characterize most security prices. But market microstructure studies have shown that a lognormal diffusion does not describe very well price formation at the shortest intervals. This is especially true of short-term bond returns. Bond price changes are mostly small, but the tails of the distribution are fatter than the lognormal allows and occasional non-diffusive jumps do seem to occur. Also, the intervals between price changes vary considerably in length. Alternative distributions have been proposed, but they do not have the convenient mathematical properties of the lognormal, so implementation can be challenging. Hainaut and MacGilchrist propose using the normal inverse Gaussian (NIG) distribution that arises from a particular Levy process and develop a lattice implementation for pricing. A pentanomial tree incorporates the NIG by matching its first four moments. In a simulation exercise, the NIG consistently outperforms the lognormal, largely due to its ability to capture skewness in returns.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"27 1","pages":"33-45"},"PeriodicalIF":0.7,"publicationDate":"2010-09-11","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"91262886","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper proposes a convenience yield-based pricing for commodity futures, which embeds the incompleteness of commodity futures markets in convenience yield. By using the pricing method, we conduct empirical analyses of crude oil, heating oil, and natural gas futures traded on the NYMEX in order to assess the incompleteness of energy futures markets. We show that the fluctuation from incompleteness is partly owed to the fluctuation from convenience yield. In addition, it is shown that the additional Sharpe ratio, which represents the degree of market incompleteness and is also used for derivative pricing written on energy prices, is obtained from the NYMEX data. Then, we apply the implied market price of risk to the pricing of Asian call option on crude oil futures. As an empirical example, we try to compute the call option price using the parameters estimated from crude oil futures prices.
{"title":"Convenience Yield-Based Pricing of Commodity Futures","authors":"Takashi Kanamura","doi":"10.2139/ssrn.1340412","DOIUrl":"https://doi.org/10.2139/ssrn.1340412","url":null,"abstract":"This paper proposes a convenience yield-based pricing for commodity futures, which embeds the incompleteness of commodity futures markets in convenience yield. By using the pricing method, we conduct empirical analyses of crude oil, heating oil, and natural gas futures traded on the NYMEX in order to assess the incompleteness of energy futures markets. We show that the fluctuation from incompleteness is partly owed to the fluctuation from convenience yield. In addition, it is shown that the additional Sharpe ratio, which represents the degree of market incompleteness and is also used for derivative pricing written on energy prices, is obtained from the NYMEX data. Then, we apply the implied market price of risk to the pricing of Asian call option on crude oil futures. As an empirical example, we try to compute the call option price using the parameters estimated from crude oil futures prices.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"32 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2010-07-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"91272498","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We propose a parsimonious multi-asset Heston model and provide an easy-to-implement calibration algorithm. The model is customized to pricing multi-asset options in markets with liquidly traded single-asset options but no liquidly traded cross-asset options. In this situation, single-asset model parameters can be calibrated from option price data, however, cross-asset parameters cannot. We formulate a parsimonious model specification such that all single-asset models are Heston models, which are affine allowing for efficient calibration of the respective parameters. The single-asset models are correlated using cross-asset correlations only. Cross-asset correlations are observable, in contrast to correlations of latent variables such as volatilities, and serve as basis for calibration. A hybrid calibration approach for identifying the model parameters consistent with option price data and asset price data is outlined and illustrated by a case study. In banking practice the approach is referred to as correlation adjustment.
{"title":"A Parsimonious Multi-Asset Heston Model: Calibration and Derivative Pricing","authors":"G. Dimitroff, S. Lorenz, Alexander Szimayer","doi":"10.2139/ssrn.1435199","DOIUrl":"https://doi.org/10.2139/ssrn.1435199","url":null,"abstract":"We propose a parsimonious multi-asset Heston model and provide an easy-to-implement calibration algorithm. The model is customized to pricing multi-asset options in markets with liquidly traded single-asset options but no liquidly traded cross-asset options. In this situation, single-asset model parameters can be calibrated from option price data, however, cross-asset parameters cannot. We formulate a parsimonious model specification such that all single-asset models are Heston models, which are affine allowing for efficient calibration of the respective parameters. The single-asset models are correlated using cross-asset correlations only. Cross-asset correlations are observable, in contrast to correlations of latent variables such as volatilities, and serve as basis for calibration. A hybrid calibration approach for identifying the model parameters consistent with option price data and asset price data is outlined and illustrated by a case study. In banking practice the approach is referred to as correlation adjustment.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"451 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2010-04-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"78278954","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2010-04-01DOI: 10.1017/S002210901000013X
M. Cremers, David R. Weinbaum
Deviations from put-call parity contain information about future stock returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations, we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 50 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, which cannot be explained by short sale constraints. Rebate rates from the stock lending market directly confirm that our findings are not driven by stocks that are hard to borrow. The degree of predictability is larger when option liquidity is high and stock liquidity low, while there is little predictability when the opposite is true. Controlling for size, option prices are more likely to deviate from strict put-call parity when underlying stocks face more information risk. The degree of predictability decreases over the sample period. Our results are consistent with mispricing during the earlier years of the study, with a gradual reduction of the mispricing over time.
{"title":"Deviations from Put-Call Parity and Stock Return Predictability","authors":"M. Cremers, David R. Weinbaum","doi":"10.1017/S002210901000013X","DOIUrl":"https://doi.org/10.1017/S002210901000013X","url":null,"abstract":"Deviations from put-call parity contain information about future stock returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations, we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 50 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, which cannot be explained by short sale constraints. Rebate rates from the stock lending market directly confirm that our findings are not driven by stocks that are hard to borrow. The degree of predictability is larger when option liquidity is high and stock liquidity low, while there is little predictability when the opposite is true. Controlling for size, option prices are more likely to deviate from strict put-call parity when underlying stocks face more information risk. The degree of predictability decreases over the sample period. Our results are consistent with mispricing during the earlier years of the study, with a gradual reduction of the mispricing over time.","PeriodicalId":40006,"journal":{"name":"Journal of Derivatives","volume":"23 1","pages":""},"PeriodicalIF":0.7,"publicationDate":"2010-04-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"83565363","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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