We argue that default option is important for equity valuation and construct a model that explicitly prices the option to default or abandon the firm. An investment strategy that buys stocks that are classified as undervalued by our model and shorts overvalued stocks generates an annual 4-factor...

This paper presents a robust new finding that there is a significantly negative relation between the equity option returns and the forward-looking volatility-of-volatility (VOV). After controlling for numerous existing option and stock characteristics, the VOV effect remains significantly...

We introduce a discrete-time model for log-return dynamics with observable volatility and jumps. Our proposal extends the class of Realized Volatility heterogeneous auto-regressive gamma (HARG) processes adding a jump component with time-varying intensity. The model is able to reproduce the...

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...

Speculators who wish to bet on higher future volatility often purchase options to “go long volatility.” Should investors who buy options expect to profit when realized volatility increases? If so, under what conditions? To answer these questions, we conduct an analysis of the relationship...

In informationally efficient financial markets, option prices and this implied volatility should immediately be adjusted to new information that arrives along with a jump in underlying's return, whereas gradual changes in implied volatility would indicate market inefficiency. Using...

In equity option markets, traders face margin requirements both for the options themselves and for hedging-related positions in the underlying stock market. We show that these requirements carry a significant margin premium in the cross-section of equity option returns. The sign of the margin...

The recent literature provides conflicting empirical evidence on the pricing of idiosyncratic risk. This paper sheds new light on the matter by exploiting the richness of option data. First, we find that idiosyncratic risk explains 28% of the variation in the risk premium on a stock. Second, we...

We develop a tractable equilibrium asset pricing model with Cumulative Prospect Theory (CPT) preferences. Using GMM on a sample of U.S. equity index option returns, we show that by introducing a single common probability weighting parameter for both tails of the return distribution, the CPT...

When the pricing kernel is U-shaped, then expected returns of claims with payout on the upside are negative for strikes beyond a threshold, determined by the slope of the U-shaped kernel in its increasing region, and have negative partial derivative with respect to strike in the increasing...