Bridge over ocean
1 November 2016 Financial Analysts Journal Volume 72, Issue 6

Option-Implied Equity Risk and the Cross Section of Stock Returns

  1. Te-Feng Chen
  2. San-Lin Chung
  3. Wei-Che Tsai

In our study, we take advantage of the forward-looking nature of information in option prices to estimate systematic equity risk while controlling for the effect of idiosyncratic skewness. Empirical results show a significantly positive relationship between the option-implied beta estimate and subsequent stock returns. A long–short portfolio based on our beta estimate earned an average monthly return of 0.96%. We also find that the option-implied beta predicts future realized betas and that the risk premium on the option-implied beta is positively associated with future market returns and contains information about future macroeconomic variables.

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