Skewness Term-Structure Tests

Thorsten Lehnert and Yuehao Lin

Applied Mathematical Finance, 2016, vol. 23, issue 6, 484-504

Abstract: In this paper, we conduct skewness term-structure tests to check whether the temporal structure of risk-neutral skewness is consistent with rational expectations. Because risk-neutral skewness is substantially mean reverting, skewness shocks should decay quickly and risk-neutral skewness of more distant option should display the rationally expected smoothing behaviour. Using an equilibrium asset and option-pricing model in a production economy under jump diffusion with stochastic jump intensity, we derive this elasticity analytically. In an empirical application of the model using more than 20 years of data on S&P500 index options, we find that this elasticity turns out to be different than suggested under rational expectations – smaller on the short end (underreaction) and larger on the long end (overreaction) of the ‘skewness curve’.

Date: 2016
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Working Paper: Skewness Term Structure Tests (2014)
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DOI: 10.1080/1350486X.2017.1310624

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