Aretz, Kevin and Lin, Ming-Tsung and Poon, Ser-Huang (2022) 'Moneyness, Underlying Asset Volatility, and the Cross-Section of Option Returns.' Review of Finance. ISSN 1382-6662 (In Press)
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AretzLinPoon_OptionReturns_Complete_CondRFAccept_13Dec2021.pdf - Accepted Version Restricted to Repository staff only until 1 January 2100. Download (1MB) | Request a copy |
Abstract
We study the effect of an asset’s volatility on the expected returns of European options on the asset. Deriving predictions from a stochastic discount factor model, we show that the effect depends on whether variations in the asset’s volatility are driven by systematic or idiosyncratic volatility. While idiosyncratic-volatility-induced variations only affect the option elasticity, systematic-volatility-induced variations also oppositely affect the expected return of the asset. Since the expected asset return (elasticity) effect dominates for options with more linear (non-linear) payoffs, systematic volatility prices sufficiently in-the-money (out-of-the-money) options with the opposite (same) sign as idiosyncratic volatility. Using single-stock calls as test assets, double-sorted portfolios and Fama-MacBeth (1973) regressions broadly support the model’s predictions.
Item Type: | Article |
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Uncontrolled Keywords: | Asset pricing; Option returns; Moneyness; Total, systematic, and idiosyncratic volatility |
Divisions: | Faculty of Social Sciences Faculty of Social Sciences > Essex Business School Faculty of Social Sciences > Essex Business School > Essex Finance Centre |
SWORD Depositor: | Elements |
Depositing User: | Elements |
Date Deposited: | 20 Dec 2021 14:00 |
Last Modified: | 23 May 2022 15:37 |
URI: | http://repository.essex.ac.uk/id/eprint/31904 |
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