Option-implied Betas, Moment Risk Premia and Stock Returns
Thesis or dissertation
University of Exeter
This thesis examines how stock returns are determined by different ex ante risk factors implied from options; these ex ante risk factors include option-implied betas, the variance, skew and kurtosis risk premia. I first compare different option-implied beta measures in future stock return prediction on the basis of Buss and Vilkov (2012). The option-implied beta proposed by Buss and Vilkov (2012) (BV) is found to outperform other beta approaches included in the research. I also propose the implied downside betas and find that the BV implied downside beta performs best and offers an improvement over the BV implied beta. However, the relationship between option-implied or implied downside betas and stock returns is not robust to firm-level variables such as firm size, book-to-market ratio or option-implied moments. These variables are correlated with option-implied betas and implied downside betas, which may obscure the beta-return relationship. Next, I investigate comprehensively whether the moment risk premia are able to predict the cross-section of stock returns. Cross-sectionally, I find that the variance, skew and kurtosis risk premia are determined differently by firm-level and risk factors. I also find that the moment risk premia have different effects on stock returns. For ex post realised stock returns, there is a negative relationship with both the variance and skew risk premia. However, the kurtosis risk premium has a noisy and insignificant relationship with realised stock returns. The price target expected return (PTER) and the implied cost of capital (ICC) are adopted as proxies for ex ante expected stock returns. I demonstrate that there is a significantly negative relationship between the variance and skew risk premia and expected stock returns, while there is a significantly positive relationship between the kurtosis risk premium and expected stock returns. The results are robust to firm-level and risk factors, sub-periods and different maturities. 3 Finally, I investigate whether the moment risk premia are able to explain future index returns at the aggregate stock market level; they are found to have different impacts on index returns depending on the return measure. Both the variance and skew risk premia are inversely related to subsequent realised S&P 500 index returns; however, the variance risk premium has a stronger relationship than the skew risk premium. The kurtosis risk premium has no effect on realised index returns. For the index price target expected return (PTER), neither the variance risk premium nor the skew risk premium has explanatory power with the PTER, while the kurtosis risk premium has a robust and positive relationship with the PTER. For the index implied cost of capital (ICC), both the variance and skew risk premia are significantly and positively related to the ICC, while the kurtosis risk premium has a significantly negative relationship with the ICC. However, the relationships between the moment risk premia and the ICC are not robust to macroeconomic variables. I also find that both the PTER and the ICC can be explained by macroeconomic factors.
PhD in Finance