Option-implied equity risk and the cross section of stock returns

Abstract

In our study, we take advantage of the forward-looking nature of information in option prices to estimate systematic equity risk while controlling for the effect of idiosyncratic skewness. Empirical results show a significantly positive relationship between the option-implied beta estimate and subsequent stock returns. A long-short portfolio based on our beta estimate earned an average monthly return of 0.96%. We also find that the option-implied beta predicts future realized betas and that the risk premium on the option-implied beta is positively associated with future market returns and contains information about future macroeconomic variables.