Informativeness of truncation in the options market

Geul Lee, Doojin Ryu and Li Yang

Finance Research Letters, 2025, vol. 72, issue C

Abstract: Truncation—the absence of deep out-of-the-money option price observations—exhibits significant underlying return predictive and forecasting power. Incorporating truncation into S&P500 spot return models improves both in-sample predictive accuracy and out-of-sample forecasting performance. The close relationship between truncation, underlying returns, and option-implied moments offers a potential explanation for its prediction capabilities. Truncation is not merely noise but contains valuable return-predictive information that may systematically influence the performance of implied moment estimates.

Keywords: Domain stabilization; Option-implied moments; Return prediction; S&P500 options; Truncation (search for similar items in EconPapers)
JEL-codes: C14 C58 G13 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:72:y:2025:i:c:s1544612324015198

DOI: 10.1016/j.frl.2024.106490

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