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Does Risk-Neutral Skewness Predict the Cross-Section of Equity Option Portfolio Returns?

Published online by Cambridge University Press:  19 August 2013

Turan G. Bali  and
Scott Murray
Turan G. Bali
Affiliation:
tgb27@georgetown.edu, McDonough School of Business, Georgetown University, 37th and O Sts, Washington, DC 20057.
Scott Murray
Affiliation:
smurray6@unl.edu, College of Business Administration, University of Nebraska-Lincoln, PO Box 880490, Lincoln, NE 68588.
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Abstract

We investigate the pricing of risk-neutral skewness in the stock options market by creating skewness assets comprised of two option positions (one long and one short) and a position in the underlying stock. The assets are created such that exposure to changes in the underlying stock price (delta), and exposure to changes in implied volatility (vega) are removed, isolating the effect of skewness. We find a strong negative relation between risk-neutral skewness and the skewness asset returns, consistent with a positive skewness preference. The returns are not explained by well-known market, size, book-to-market, momentum, short-term reversal, volatility, or option market factors.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 48 , Issue 4 , August 2013 , pp. 1145 - 1171
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2013 

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