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Risk-Neutral Skewness, Informed Trading, and the Cross Section of Stock Returns

Published online by Cambridge University Press:  24 July 2020

Tarun Chordia ,
Tse-Chun Lin Open the ORCID record for Tse-Chun Lin [Opens in a new window]  and
Vincent Xiang
Tarun Chordia
Affiliation:
Emory University Goizueta Business School and Deakin University Business SchoolTarun.Chordia@emory.edu
Tse-Chun Lin*
Affiliation:
Central University of Finance and Economics School of Finance and The University of Hong Kong Faculty of Business and Economicstsechunlin@hku.hk
Vincent Xiang
Affiliation:
Deakin University Business Schoolv.xiang@deakin.edu.au
*
tsechunlin@hku.hk (corresponding author)
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Abstract

In this article, we use volatility surface data from options contracts to document a strong, robust, and positive cross-sectional relation between risk-neutral skewness (RNS) and subsequent stock returns. The differential return between high- and low-RNS stocks amounts to 0.17% per week. Preannouncement RNS is positively related to earnings announcement returns, and the positive RNS–return relation is more pronounced for other nonscheduled news releases. This suggests that it is informed trading that drives the positive relation between RNS and subsequent stock returns. We also find that RNS contains incremental information beyond trading signals captured by option-implied volatility and volume.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 5 , August 2021 , pp. 1713 - 1737
Copyright
© The Author(s), 2020. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

We thank Doron Avramov, Turan Bali (the referee), Zhanhui Chen, Michael Chng, Stephen Figlewski, Bruce Grundy, Jianfeng Hu, Ed Lin, Neil Pearson, Sungjune Pyun, Grigory Vilkov, Jianfeng Yu, and participants at the 2019 Chinese University of Hong Kong Derivatives & Quantitative Investing Conference, 2019 China International Conference in Finance (CICF), 2018 Society for Financial Studies (SFS) Cavalcade Asia-Pacific conference, Fudan University, and Monash University for helpful comments. Any remaining errors are our own.

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