Risk-neutral skewness and stock market returns: A time-series analysis

Xiaowei Li, Zhengyu Wu, Hao Zhang and Lu Zhang

The North American Journal of Economics and Finance, 2024, vol. 70, issue C

Abstract: This paper investigates whether the change of average risk-neutral skewness (RNS), which is the average of monthly risk-neutral skewness across firms, can predict subsequent aggregate stock returns. We find that average RNS positively and significantly predicts future aggregate stock returns, consistent with the firm-level evidence. Our findings are robust after controlling for other well-documented financial and economic stock return predictors. Moreover, we document that the robustness of predictability still holds in out-of-sample settings. Finally, we show that the forecasting ability of average RNS stems from its better performances during the economic recession rather than economic expansion and its pronounced predictability among stocks that are more speculative and difficult to arbitrage.

Keywords: Risk-neutral skewness; Return predictability; Out-of-sample prediction; Arbitrage constraints (search for similar items in EconPapers)
JEL-codes: C22 C53 G11 G12 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:70:y:2024:i:c:s1062940823001638

DOI: 10.1016/j.najef.2023.102040

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