Skip to main content
×
Home

Risk-Neutral Skewness: Evidence from Stock Options

  • Patrick Dennis (a1) and Stewart Mayhew (a2)
Abstract
Abstract

We investigate the relative importance of various factors in explaining the volatility skew observed in the prices of stock options traded on the Chicago Board Options Exchange. The skewness of the risk-neutral density implied by individual stock option prices tends to be more negative for stocks that have larger betas, suggesting that market risk is important in pricing individual stock options. Also, implied skewness tends to be more negative in periods of high market volatility, and when the risk-neutral density for index options is more negatively skewed. Other firm-specific factors, including firm size and trading volume a so help explain cross-sectional variation in skewness. However, we find no robust relationship between skewness and the firm's leverage. Nor do we find evidence that skewness is related to the put/call ratio, which may be viewed as a proxy for trading pressure or market sentiment. Overall, firm-specific factors seem to be more important than systematic factors in explaining the variation in the skew for individual firms.

Copyright
References
Hide All
Bakshi G.; Kapadia N.; and Madan D.. “Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options.” Review of Financial Studies (forthcoming).
Bakshi G., and Madan D.. “Spanning and Derivative Security Valuation.” Journal of Financial Economics, 55 (2000), 205238.
Black F., and Scholes M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637659.
Breeden D., and Litzenberger R.. “Prices of State-Contingent Claims Implicit in Option Prices.” Journal of Business, 51 (1978), 621652.
Fama E., and French K.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427465.
Fama E., and MacBeth J.. “Risk, Return and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607636.
Figlewski S.Options Arbitrage in Imperfect Markets.” Journal of Finance, 44 (1989), 12891311.
Figlewski S., and Wang X.. “Is the ‘Leverage Effect’ a Leverage Effect?” Working Paper, New York Univ. and City Univ. of Hong Kong (2000).
Franke G.; Stapleton R.; and Subrahmanyam M.. “When are Options Overpriced: The Black-Scholes Model and Alternative Characterizations of the Pricing Kernel.” European Finance Review, 3 (1999), 79102.
Geske R.The Valuation of Compound Options.” Journal of Financial Economics, 7 (1979), 6381.
Jackwerth J.Option Implied Risk-Neutral Distributions and Implied Binomial Trees: A Literature Review.” Journal of Derivatives, 7 (1999), 6682.
MacBeth J., and Merville L.. “An Empirical Examination of the Black-Scholes Call Option Pricing Model.” Journal of Finance, 34 (1979), 11731186.
Rubinstein M.Nonparametric Tests of Alternative Option Pricing Models Using All Reported Trades and Quotes on the 30 Most Active CBOE Option Classes from August 23, 1976, through August 31, 1978.” Journal of Finance, 40 (1985), 455480.
Rubinstein M.Implied Binomial Trees.” Journal of Finance, 49 (1994), 771818.
Shimko D.Bounds of Probability.” Risk, 6 (1993), 3337.
Toft K., and Prucyk B.. “Options on Leveraged Equity: Theory and Empirical Tests.” Journal of Finance, 52 (1997), 11511180.
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? *
×

Metrics

Full text views

Total number of HTML views: 0
Total number of PDF views: 65 *
Loading metrics...

Abstract views

Total abstract views: 343 *
Loading metrics...

* Views captured on Cambridge Core between September 2016 - 14th December 2017. This data will be updated every 24 hours.