We demonstrate that an ex-ante measure of expected returns based on analyst price targets is highly related to the market's required rate of return. We then show that ex-ante measures of volatility, skewness, and kurtosis derived from option prices are positively related to ex-ante expected returns. While expected returns are related to both systematic and unsystematic variance risk, only the unsystematic components of skewness and kurtosis are important for explaining the cross-section of expected stock returns. The results are consistent using different measures of ex-ante risk and robust to controls for other variables related to stock returns and analyst bias.
Risk-Neutral Moments, Option-Implied Risk, Ex-Ante Expected Stock Returns, Price Targets
Finance and Financial Management
Georgetown McDonough School of Business Research Paper
BALI, Turan; HU, Jianfeng; and SCOTT, Murray.
Option Implied Volatility, Skewness, and Kurtosis and the Cross-Section of Expected Stock Returns. (2017). 1-81. Research Collection Lee Kong Chian School Of Business.
Available at: http://ink.library.smu.edu.sg/lkcsb_research/3611
Creative Commons License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.