Option Implied Volatility, Skewness, and Kurtosis and the Cross-Section of Expected Stock Returns

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Working Paper

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We investigate the cross-sectional relation between the market's ex-ante view of the volatility, skewness, and kurtosis of the risk-neutral distribution implied from option prices, and ex-ante expected stock returns, calculated from analyst price targets. We find that ex-ante expected returns are strongly positively related to each of the total risk-neutral moments (volatility, skewness, and kurtosis). We then decompose each of the risk-neutral moments into systematic and unsystematic components. The results show that both the systematic and unsystematic portions of variance, skewness, and kurtosis are positively related to ex-ante expected returns. Defining the volatility, skewness, and kurtosis risk premia as the difference between the risk-neutral and physical moments, we also demonstrate that each of these risk premia is positively related to expected returns. The results are consistent using two different approaches to measuring risk-neutral moments 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

Research Areas