This paper presents the first comparison of the accuracy of density forecasts for stock prices. Six sets of forecasts are evaluated for DJIA stocks, across four forecast horizons. Two forecasts are risk-neutral densities implied by the Black-Scholes and Heston models. The third set are...

This paper studies the factor structure of the cross-section of delta-hedged equity option returns. We find that a four-factor model explains the cross-section and time-series of equity option returns. Out of the four factors, three are characteristic based factors from the long-short option...

This paper studies the effects of default risk on equity option returns. We show that there is a cross-sectional and a time-series relation between default risk and option returns. In the cross-section, expected delta-hedged equity option returns have a negative relation with default risk...

The Black-Scholes framework implies a constant volatility across term and strike, and a lognormal distribution for underlying asset prices. However, it is known that empirical data violates this assumption. In this report we describe, motivate and apply a model-independent,...

This paper evaluates the underperformance of individual equity options relative to their replicating portfolios. Considering a high-dimensional set of variables, we use a machine learning approach to identify the characteristics of options and their underlying stocks that provide incremental...

We provide evidence of a strong effect of the underlying stock's illiquidity on option prices by showing that the average absolute difference between historical and implied volatility increases with stock illiquidity. This pattern translates into significant excess returns of option trading...

Equity option markets exhibit intense trading activity. We use the variability of option implied volatility spread as a proxy for the impounding of new information, and changes in the interpretation of existing information, into option prices. Over the 2006 – 2016 period, we find that the...

Many financial instruments are designed with embedded leverage such as options and leveraged exchange traded funds (ETFs). Embedded leverage alleviates investors' leverage constraints and, therefore, we hypothesize that embedded leverage lowers required returns. Consistent with this hypothesis,...

Standard deviations of the volatility premium, of implied volatility innovations, and of the volatility term structure spread in equity options help explain the cross-section of one-month-ahead underlying stock returns. The explanatory power from standard deviations is robust to the levels of...

We develop an ex-ante measure of expected stock returns based on analyst price targets. We then show that ex-ante measures of volatility, skewness, and kurtosis implied from stock option prices are positively related to the cross section of ex-ante expected stock returns. While expected returns...