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

Te-Feng Chen, San-Lin Chung and Wei-Che Tsai

Financial Analysts Journal, 2016, vol. 72, issue 6, 42-55

Abstract: 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.Editor’s note: This article was reviewed and accepted by Robert Litterman, executive editor at the time the article was submitted.

Date: 2016
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DOI: 10.2469/faj.v72.n6.2

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