Skip to main content

Predictable Dynamics in Higher-Order Risk-Neutral Moments: Evidence from the S&P 500 Options

  • Michael Neumann (a1) and George Skiadopoulos (a2)

We investigate whether there are predictable patterns in the dynamics of higher-order risk-neutral moments (RNMs) extracted from the market prices of Standard & Poor’s (S&P) 500 index options. To this end, we conduct a horse race among alternative forecasting models within an out-of-sample context over various forecasting horizons. We consider both a statistical and an economic setting. We find that higher RNMs can be statistically forecasted. However, only the 1-day-ahead skewness forecasts can be economically exploited. This economic significance vanishes once we incorporate transaction costs. The results have implications for the dynamics of implied volatility surfaces.

Hide All
Ait-Sahalia, Y.; Wang, Y.; and Yared, F.. “Do Option Markets Correctly Price the Probabilities of Movement of the Underlying Asset?Journal of Econometrics, 102 (2001), 67110.
Bakshi, G.; Cao, C.; and Chen, Z.. “Empirical Performance of Alternative Option Pricing Models.” Journal of Finance, 52 (1997), 20032049.
Bakshi, G.; Kapadia, N.; and Madan, D.. “Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options.” Review of Financial Studies, 16 (2003), 101143.
Bakshi, G., and Madan, D.. “A Theory of Volatility Spreads.” Management Science, 52 (2006), 112.
Bakshi, G.; Panayotov, G.; and Skoulakis, G.. “Improving the Predictability of Real Economic Activity and Asset Returns with Forward Variances Inferred from Option Portfolios.” Journal of Financial Economics, 100 (2011), 475495.
Bali, T. G., and Murray, S.. “Does Risk-Neutral Skewness Predict the Cross-Section of Equity Option Portfolio Returns?Journal of Financial and Quantitative Analysis, forthcoming (2013).
Blanchard, O., and Watson, M.. “Bubbles, Rational Expectations, and Financial Markets.” In Crises in the Economic and Financial Structure, Wachter, P., ed. Lexington, MA: Lexington Books (1982).
Bollen, N. P., and Whaley, R. E.. “Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?Journal of Finance, 59 (2004), 711753.
Bollerslev, T.; Tauchen, G.; and Zhou, H.. “Expected Stock Returns and Variance Risk Premia.” Review of Financial Studies, 22 (2009), 44634492.
Broadie, M.; Chernov, M.; and Johannes, M.. “Understanding Index Option Returns.” Review of Financial Studies, 22 (2009), 44934529.
Campbell, J. Y., and Hentschel, L.. “No News Is Good News: An Asymmetric Model of Changing Volatility in Stock Returns.” Journal of Financial Economics, 31 (1992), 281318.
Carr, P., and Wu, L.. “Variance Risk Premiums.” Review of Financial Studies, 22 (2009), 13111341.
Chang, B. Y.; Christoffersen, P.; and Jacobs, K.. “Market Skewness Risk and the Cross-Section of Stock Returns.” Journal of Financial Economics, 107 (2013), 4668.
Cremers, M., and Weinbaum, D.. “Deviations from Put-Call Parity and Stock Return Predictability.” Journal of Financial and Quantitative Analysis, 45 (2010), 335367.
David, A., and Veronesi, P.. “Option Prices with Uncertain Fundamentals.” Working Paper, University of Chicago (2002).
Dennis, P., and Mayhew, D.. “Risk-Neutral Skewness: Evidence from Stock Options.” Journal of Financial and Quantitative Analysis, 37 (2002), 471492.
Dumas, B.; Fleming, J.; and Whaley, R. E.. “Implied Volatility Functions: Empirical Tests.” Journal of Finance, 53 (1998), 20162059.
Gârleanu, N.; Pedersen, L. H.; and Poteshman, A. M.. “Demand-Based Option Pricing.” Review of Financial Studies, 22 (2009), 42594299.
Ghysels, E.; Plazzi, A.; and Valkanov, R.. “Conditional Skewness of Stock Market Returns in Developed and Emerging Markets and Its Economic Fundamentals.” Working Paper, University of North Carolina at Chapel Hill (2011).
Giamouridis, D., and Skiadopoulos, G.. “The Informational Content of Financial Options for Quantitative Asset Management: A Review.” In Handbook of Quantitative Asset Management, Scherer, B. and Winston, K., eds. Oxford University Press (2012), 243265.
Gonçalves, S., and Guidolin, M.. “Predictable Dynamics in the S&P 500 Index Options Implied Volatility Surface.” Journal of Business, 79 (2006), 15911635.
Guidolin, M., and Timmermann, A.. “Option Prices under Bayesian Learning: Implied Volatility Dynamics and Predictive Densities.” Journal of Economic Dynamics and Control, 27 (2003), 717769.
Hansen, P. R.; Lunde, A.; and Nason, J. M.. “The Model Confidence Set.” Econometrica, 79 (2011), 453497.
Hansis, A.; Schlag, C.; and Vilkov, G.. “The Dynamics of Risk-Neutral Implied Moments: Evidence from Individual Options.” Working Paper, Goethe University, Frankfurt am Main (2010).
Harvey, C. R., and Siddique, A.. “Autoregressive Conditional Skewness.” Journal of Financial and Quantitative Analysis, 34 (1999), 465487.
Harvey, C. R., and Siddique, A.. “Conditional Skewness in Asset Pricing Tests.” Journal of Finance, 55 (2000), 12631295.
Harvey, C. R., and Whaley, R. E.. “Market Volatility Prediction and the Efficiency of the S&P 100 Index Option Market.” Journal of Financial Economics, 31 (1992), 4373.
Harvey, D.; Leybourne, S.; and Newbold, P.. “Testing the Equality of Prediction Mean Squared Errors.” International Journal of Forecasting, 13 (1997), 281291.
Hong, H., and Stein, J. C.. “Differences of Opinion, Short-Sales Constraints, and Market Crashes.” Review of Financial Studies, 16 (2003), 487525.
Jha, R., and Kalimipalli, M.. “The Economic Significance of Conditional Skewness Forecasts in Index Option Markets.” Journal of Futures Markets, 30 (2010), 378406.
Jiang, G. J., and Tian, Y. S.. “The Model-Free Implied Volatility and Its Information Content.” Review of Financial Studies, 18 (2005), 13051342.
Johansen, S. “Statistical Analysis of Cointegrating Vectors.” Journal of Economic Dynamics and Control, 12 (1988), 231254.
Kang, B. J.; Kim, T. S.; and Yoon, S.-J.. “Information Content of Volatility Spreads.” Journal of Futures Markets, 30 (2010), 533558.
Konstantinidi, E.; Skiadopoulos, G.; and Tzagkaraki, E.. “Can the Evolution of Implied Volatility Be Forecasted? Evidence from European and US Implied Volatility Indices.” Journal of Banking and Finance, 32 (2008), 24012411.
Kostakis, A.; Panigirtzoglou, N.; and Skiadopoulos, G.. “Market Timing with Option-Implied Distributions: A Forward-Looking Approach.” Management Science, 57 (2011), 12311249.
Kozhan, R.; Neuberger, A.; and Schneider, P.. “The Skew Risk Premium in the Equity Index Market.” Review of Financial Studies, 26 (2013), 21742203.
Leland, H. E. “Beyond Mean-Variance: Performance Measurement in a Nonsymmetrical World.” Financial Analysts Journal, 55 (1999), 2736.
Lynch, D., and Panigirtzoglou, N.. “Summary Statistics of Option-Implied Probability Density Functions and Their Properties.” Working Paper, Bank of England (2008).
Malz, A. M. “Estimating the Probability Distribution of the Future Exchange Rate from Option Prices.” Journal of Derivatives, 5 (1997), 1836.
Merton, R. “Theory of Rational Option Pricing.” Bell Journal of Economics and Management Science, 4 (1973), 141183.
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703708.
Panigirtzoglou, N., and Skiadopoulos, G.. “A New Approach to Modeling the Dynamics of Implied Distributions: Theory and Evidence from the S&P 500 Options.” Journal of Banking and Finance, 28 (2004), 14991520.
Politis, D. N., and Romano, J. P.. “The Stationary Bootstrap.” Journal of the American Statistical Association, 89 (1994), 13031313.
Santa-Clara, P., and Saretto, A.. “Option Strategies: Good Deals and Margin Calls.” Journal of Financial Markets, 12 (2009), 391417.
Taylor, S. J.; Yadav, P. K.; and Zhang, Y.. “Cross-Sectional Analysis of Risk-Neutral Skewness.” Journal of Derivatives, 16 (2009), 3852.
Xing, Y.; Zhang, X.; and Zhao, R.. “What Does the Individual Option Volatility Smirk Tell Us About Future Equity Returns?Journal of Financial and Quantitative Analysis, 45 (2010), 641662.
Zhang, J. E., and Xiang, Y.. “The Implied Volatility Smirk.” Quantitative Finance, 8 (2008), 263284.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Journal of Financial and Quantitative Analysis
  • ISSN: 0022-1090
  • EISSN: 1756-6916
  • URL: /core/journals/journal-of-financial-and-quantitative-analysis
Please enter your name
Please enter a valid email address
Who would you like to send this to? *
Type Description Title
Supplementary materials

Michael Neumann Supplementary Material

 PDF (78 KB)
78 KB


Full text views

Total number of HTML views: 0
Total number of PDF views: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed