# Research

OptionMetrics data is an essential component of many studies performed by both academics and practitioners. Below is a partial list of academic papers that used OptionMetrics data:

## Research by:

### A. Langer and D. Lemoine: "What Were the Odds? Estimating the Market's Probability of Uncertain Events"

December 1, 2020

An event study generates only a lower bound on the full effect of an event unless researchers know the probability that investors assigned to the event before it occurred. We develop two model-free methods for recovering the market’s priced-in probability of events. These methods require running event studies in financial options to complement the standard event study in stock prices. Validating both approaches, we estimate that the 2016 U.S. election outcome had a 12% chance of occurring.

### I. Lee, R. W. Renjie, P. Verwijmeren: "How Do Options Add Value? Evidence from the Convertible Bond Market"

October 9, 2020

This paper provides evidence that the availability of individual stock options adds value to security issuers. We focus on convertible bond issues because pricing convertible bonds requires essentially the same set of information necessary to price options. By exploiting the SEC’s minimum stock price requirement for option listing to employ a regression discontinuity design, we find that the availability of stock options significantly affects the pricing of convertible bonds. In line with options providing information, the effect is stronger when the overall information environment is poor.

### F. Chabi-Yo, C. Dim, G. Vilkov: "Generalized Bounds on the Conditional Expected Excess Return on Individual Stocks"

October 8, 2020

We derive generalized bounds on conditional expected excess returns. The bounds deliver consistent expected returns for individual and index-type assets, are conditionally tight, account for all risk-neutral moments of returns, and outperform runner-up models for out-of-sample predictions. Bounds calibrated to realized returns correspond to reasonable risk aversion and prudence. On average, expected stock returns given by the bounds decrease on FOMC days and even weeks of the FOMC cycle. However, using a composite sensitivity index based on asset characteristics, we also identify stocks experiencing an increase in expected returns.

### K. Aretz, I. Garrett, A. Gazi: "Taking Money Off the Table: Suboptimal Early Exercises, Risky Arbitrage, and American Put Returns"

October 7, 2020

Many studies report that American option investors often exercise their positions suboptimally late. Yet, when that can happen in case of puts, there is an arbitrage opportunity in perfect markets, exploitable by longing the asset-and-riskfree-asset portfolio replicating the put and shorting the put. Using early exercise data, we show that the arbitrage strategy also earns a highly significant mean return with low risk in real single-stock put markets, in which exactly replicating options is impossible.

### J. Jackwerth: "Does the Ross recovery theorem work empirically?"

September 1, 2020

Starting with the fundamental relation that state prices are the product of physical probabilities and the stochastic discount factor, Ross (2015) shows that, given strong assumptions, knowing state prices suffices to back out physical probabilities and the stochastic discount factor at the same time. We find that such recovered physical distributions based on the S&P 500 index are incompatible with future returns and fail to predict future returns and realized variances.

August 7, 2020

### T. Bali and S. Murray: "Does Risk-Neutral Skewness Predict the Cross-Section of Equity Option Portfolio Returns?"

February 20, 2012

We investigate the pricing of risk-neutral skewness in the stock options market by creating skewness assets comprised of two option positions (one long and one short) and a position in the underlying stock. The assets are created such that exposure to changes in the price of the underlying stock (delta), and exposure to changes in implied volatility (vega) are removed, isolating the effect of skewness. We find a strong negative relation between implied risk-neutral skewness and the returns of the skewness assets, consistent with a positive skewness preference.

### A. Buss, C. Schlag, and G. Vilkov: "CAPM with Option-Implied Betas: Another Rescue Attempt"

February 20, 2012

We test the conditional CAPM with time-varying forward-looking betas, assuming a two-state model for the market risk premium. For market state identification we employ a recursive Markov-switching model based on a forward-looking Sentiment factor. The empirical results for our sample of S&P500 constituents for the period from 1996 to 2007 show that in ‘good’ states of the economy the classical CAPM with just the market factor is able to explain the cross-section of expected returns very well, while in ‘bad’ states firm characteristics like size and book-to-market become relevant.

### A. Takeyama, N. Constantinou, and D. Vinogradow: "A Framework for Extracting the Probability of Default from Listed Stock Option Prices"

February 20, 2012

This paper develops a framework to estimate the probability of default (PD) implied in listed stock options. The underlying option pricing model measures PD as the intensity of the jump diffusion that the underlying stock price becomes zero. We adopt a two stage calibration algorithm to obtain the precise estimator of PD. In the calibration procedure, we improve the fitness of the option pricing model via the implementation of the time inhomogeneous term structure model in the option pricing model.

### W. Jin, J. Livnat, and Y. Zhang: "Option Prices Leading Equity Prices: Do Option Traders Have an Information Advantage?"

January 10, 2012

Recent evidence shows that option volatility skews and volatility spreads between call and put options predict equity returns. This study investigates whether such predictive ability is driven by option traders’ information advantage. We examine the predictive ability of volatility skews and volatility spreads around significant information events including earnings announcements, other firm-specific information events, and events that trigger significant market reactions. Consistent with option traders having an information advantage relative to equity traders before information events, we find that the option measures immediately before these events have higher predictive ability for short-term event returns than they do in a more dated window or before a randomly selected pseudo-event.

### L. Stentoft: "What We Can Learn from Pricing 139,879 Individual Stock Options"

December 22, 2011

The GARCH framework has been used for option pricing with quite some success. While the initial work assumed conditional Gaussian innovations, recent contributions relax this assumption and allow for more flexible parametric specifications of the underlying distribution. However, until now the empirical applications have been limited to index options or options on only a few stocks and this using only few potential distributions and variance specifications. In this paper we test the GARCH framework on 30 stocks in the Dow Jones Industrial Average using two classical volatility specifications and 7 different underlying distributions.

### T. Goodman, M. Neamtiu, and F. Zhang: "Fundamental Analysis and Option Returns"

December 21, 2011

In the Merton (1973) ICAPM, state variables that capture the evolution of the investor’s opportunity set are necessary to explain observed asset prices. We show that augmenting the CAPM by a measure of market-wide volatility innovation yields a two-factor model that performs well in explaining the cross-section of returns on securities in several asset classes. The consistent pricing of volatility risk (with a negative risk premium) suggests that volatility risk indeed acts as a state variable rather than being just another statistical factor.

### D. Muravyev: "Order Flow and Expected Option Returns"

November 23, 2011

The paper presents three pieces of evidence that the inventory risk faced by market-makers has a primary effect on option prices. First, I introduce a simple method for decomposing the price impact of trades into inventory-risk and asymmetric-information components. The components are inferred from the difference between price responses of the market-maker who receives a trade and those who do not. Both price impact components are significant for option trades, but the inventory-risk component is larger.

### Z. Dha, E. Schaumburg: "The pricing of volatility risk across asset classes"

November 21, 2011

In the Merton (1973) ICAPM, state variables that capture the evolution of the investor’s opportunity set are necessary to explain observed asset prices. We show that augmenting the CAPM by a measure of market-wide volatility innovation yields a two-factor model that performs well in explaining the cross-section of returns on securities in several asset classes. The consistent pricing of volatility risk (with a negative risk premium) suggests that volatility risk indeed acts as a state variable rather than being just another statistical factor.

### A. Takeyama, N. Constantinou, and D. Vinogradov: "A Framework for Extracting the Probability of Default from Listed Stock Option Prices"

November 14, 2011

This paper develops a framework to estimate the probability of default (PD) implied in listed stock options. The underlying option pricing model measures PD as the intensity of the jump diffusion that the underlying stock price becomes zero. We adopt a two stage calibration algorithm to obtain the precise estimator of PD. In the calibration procedure, we improve the fitness of the option pricing model via the implementation of the time inhomogeneous term structure model in the option pricing model.

### K. Barraclough, D. Robinson, et. al.: "Using Option Prices to Infer Overpayments and Synergies in M&A Transactions"

October 12, 2011

In this paper, we use call option prices to identify synergies and news from merger and acquisition (M&A) transaction announcements. We find that M&A announcements result in large and approximately equal gains to the bidder and the target on average, with the combined gains being large enough to justify the premium paid to target shareholders. On average, M&A announcements release good news about targets, but bad news about bidders. This suggests that market prices understate true synergy gains, and helps reconcile the generally negative market-based evidence on value-creation in takeovers with their continued prominence in everyday business strategy.

### K. Hamidieh: "Estimating the Tail Shape Parameter from Option Prices"

October 10, 2011

This paper investigates whether fundamental accounting information is appropriately priced in the options market. We find that fundamental accounting signals exhibit incremental predictive power with respect to future option returns above and beyond what is captured by implied and historical stock volatility, suggesting that the options market does not fully incorporate fundamental information into option prices. Transaction costs substantially reduce the overall profitability of hedge strategies that exploit the information in these fundamental accounting signals, but the strategies still earn economically and statistically significant returns for options with low transaction costs.

### T. Bali, O. Demirtas, and Y. Atilgan: "Implied Volatility Spreads and Expected Market Returns."

October 1, 2011

This paper investigates the intertemporal relation between volatility spreads and expected returns on the aggregate stock market. We provide evidence for a significantly negative link between volatility spreads and expected returns at the daily and weekly frequencies. We argue that this link is driven by the information flow from option markets to stock markets. The documented relation is significantly stronger for the periods during which (i) S&P 500 constituent firms announce their earnings; (ii) cash flow and discount rate news are large in magnitude; and (iii) consumer sentiment index takes extreme values.

### M. Chesney, R. Crameri, and L. Mancini: "Detecting Informed Trading Activities in the Options Markets: Appendix on Subprime Financial Crisis"

September 22, 2011

This paper investigates whether fundamental accounting information is appropriately priced in the options market. We find that fundamental accounting signals exhibit incremental predictive power with respect to future option returns above and beyond what is captured by implied and historical stock volatility, suggesting that the options market does not fully incorporate fundamental information into option prices. Transaction costs substantially reduce the overall profitability of hedge strategies that exploit the information in these fundamental accounting signals, but the strategies still earn economically and statistically significant returns for options with low transaction costs.

### T.G. Bali and S. Murrary: "Does Risk-Neutral Skewness Predict the Cross-Section of Equity Option Portfolio Returns?”"

July 20, 2011

We investigate the pricing of risk-neutral skewness in the stock options market by creating skewness assets comprised of two option positions (one long and one short) and a position in the underlying stock. The assets are created such that exposure to changes in the price of the underlying stock (delta), and exposure to changes in implied volatility (vega) are removed, isolating the effect of skewness. We find a strong negative relation between implied risk-neutral skewness and the returns of the skewness assets, consistent with a positive skewness preference.

### F. Audrino, D. Colangelo: "Semi-parametric forecasts of the implied volatility surface using regression trees"

October 1, 2010

We present a new semi-parametric model for the prediction of implied volatility surfaces that can be estimated using machine learning algorithms. Given a reasonable starting model, a boosting algorithm based on regression trees sequentially minimizes generalized residuals computed as differences between observed and estimated implied volatilities. To overcome the poor predictive power of existing models, we include a grid in the region of interest, and implement a cross-validation strategy to find an optimal stopping value for the boosting procedure.

### J. Driessen, P. Maenhout, and G. Vilkov: "The Price of Correlation Risk: Evidence from Equity Options"

June 1, 2010

We study whether exposure to market-wide correlation shocks affects expected option returns, using data on S&P100 index options, options on all components, and stock returns. We find evidence of priced correlation risk based on prices of index and individual variance risk. A trading strategy exploiting priced correlation risk generates a high alpha and is attractive for CRRA investors without frictions. Correlation risk exposure explains the cross-section of index and individual option returns well.

### R. Elkamhi, C. Ornthanalai: "Market Jump Risk and the Price Structure of Individual Equity Options"

May 15, 2010

The role of market jump risk premium implicit in individual equity options has not been examined to date. This paper develops a new factor model for equity returns and option pricing that takes into account the market’s diffusive and jump risks. We estimate the model on a large cross section of equity returns and options. We find that market jump risk embedded in equity options is about 3.18%. This magnitude is consistent with those found in index options pricing studies which suggests that the price structure of equity and index options can be explained in a unified framework.

### S. Xiaoyan Ni, J. Pan, A.M. Poteshman: "Volatility Information Trading in the Option Market"

May 3, 2010

This study follows the approach of Ni et al. [Ni, S.X., Pan, J., Poteshman, A.M., 2008. Volatility information trading in the option market. Journal of Finance 63, 1059-1091] – based upon the vega-weighted net demand for volatility – to determine whether volatility information exists within the Taiwan options market. Our empirical results show that foreign institutional investors possess the strongest and most direct volatility information, which is realized by the delta-neutral options/futures trades.

### L. Tsiaras: "The Forecast Performance of Competing Implied Volatility Measures: The Case of Individual Stocks"

February 20, 2010

This study examines the information content of alternative implied volatility measures for the 30 components of the Dow Jones Industrial Average Index from 1996 until 2007. Along with the popular Black-Scholes and model-free” implied volatility expectations, the recently proposed corridor implied volatility (CIV) measures are explored. For all pair-wise comparisons, it is found that a CIV measure that is closely related to the model-free implied volatility, nearly always delivers the most accurate forecasts for the majority of the firms.

### Tse Chun Lin, Xiaolong Lu and Joost Driessen: "The Forecast Performance of Competing Implied Volatility Measures: The Case of Individual Stocks"

February 20, 2010

This study examines the information content of alternative implied volatility measures for the 30 components of the Dow Jones Industrial Average Index from 1996 until 2007. Along with the popular Black-Scholes and model-free” implied volatility expectations, the recently proposed corridor implied volatility (CIV) measures are explored. For all pair-wise comparisons, it is found that a CIV measure that is closely related to the model-free implied volatility, nearly always delivers the most accurate forecasts for the majority of the firms.

### M. Cao and J. Wei : "Commonality in Liquidity: Evidence from the Option Market"

February 17, 2010

This study examines the property of liquidity in the option market. Using IvyDB’s OptionMetrics data for the period of January 1, 1996 to December 31, 2004, we establish convincing evidence of commonality in options liquidity. The commonality remains strong even after controlling for the impact of the underlying stock market and other liquidity determinants. Other findings include: 1) the stock market exhibits a much stronger commonality than does the option market, 2) compared with the inventory risk, information asymmetry plays a more dominant role in influencing options liquidity and 3) the market-wide option liquidity depends on the underlying stock market’s movements – for instance, the bid-ask spread of calls decreases (increases) when the overall market goes up (down), while that of puts takes the opposite pattern.

### A. Hansis, C. Schlag, G. Vilkov : "The Dynamics of Risk-Neutral Implied Moments: Evidence from Individual Options"

February 1, 2010

We study the estimation, the dynamics, and the predictability of option-implied risk-neutral moments (variance, skewness, and kurtosis) for individual stocks from various perspectives. We first show that it is in the estimation of the higher moments essential to use an interpolation with a narrow grid as well as a wide interval. We show that implied moments are well explained cross-sectionally by a number of firm characteristics. We use the characteristics that have been shown to exhibit correlation with expected returns (like size and the market-to-book ratio of equity).

### J. Cao and B. Han: "Option Returns and Individual Stock Volatility"

November 1, 2009

This paper studies the cross-sectional determinants of delta-hedged stock option returns with an emphasis on the pricing of volatility risk. We find that the average delta-hedged option returns are significantly negative for most stocks, and their magnitudes increase monotonically with the volatility of the underlying stock.Writing covered calls on high volatility stocks on average earns about 2% more per month than selling covered calls on low volatility stocks. This spread is higher when it is more difficult to arbitrage between stock and option.

### V. Martinez, I.Rosu and C. Bester: "Option Pricing on Cash Mergers"

September 30, 2009

When a cash merger is announced but not completed, there are two main sources of uncertainty related to the target company: the probability of success and the price conditional on the deal failing. We propose an arbitrage-free option pricing formula that focuses on these sources of uncertainty. We test our formula in a study of all cash mergers between 1996 and 2008 which have sufficiently liquid options traded on the target company.

### S. Zymler, D. Kuhn, and B. Rustem: "Worst-Case Value-at-Risk of Non-linear Portfolios"

June 21, 2009

Portfolio optimization problems involving Value-at-Risk (VaR) are often computationally intractable and require complete information about the return distribution of the portfolio constituents, which is rarely available in practice. These difficulties are compounded when the portfolio contains derivatives. We develop two tractable conservative approximations for the VaR of a derivative portfolio by evaluating the worst-case VaR over all return distributions of the derivative underliers with given first- and second-order moments.The derivative returns are modelled as convex piecewise linear or—by using a delta-gamma approximation—as (possibly non-convex) quadratic functions of the returns of the derivative underliers.

### E. Maberly, R. Pierce, and P. Catania: "Threshold Levels, Strike Price Grid and Other Market Microstructure Issues Associated with Exchange Traded Equity Options"

January 24, 2009

This paper addresses a number of important market microstructure issues associated with exchange traded equity options having significant research implications for studies investigating clustering on option strike prices. Price threshold levels are examined associated with exchange listing and the automatic exercise of equity options as established by the SEC and OCC to carry out their regulatory and oversight responsibilities. Significant changes are documented including motivation for such changes. Market microstructure issues potentially impact equity options research outcomes and one important issue is documenting changes over time to the strike price grid.

### M. Ammann, D. Skovmand, and M. Verhofen: "Implied and Realized Volatility in the Cross-Section of Equity Options"

November 1, 2008

Using a complete sample of US equity options, we analyze patterns of implied volatility in the cross-section of equity options with respect to stock characteristics. We find that high-beta stocks, small stocks, stocks with a low-market-to-book ratio, and non-momentum stocks trade at higher implied volatilities after controlling for historical volatility. We find evidence that implied volatility overestimates realized volatility for low-beta stocks, small caps, low-market-to-book stocks, and stocks with no momentum and vice versa.

### S.J. Taylor, P.K Yadav, and Y. Zhang: "The Information Content of Implied Volatilities and Model-free Volatility Expectations: Evidence from Options Written on Individual Stocks"

October 8, 2008

S.J. Taylor, P.K Yadav, and Y. Zhang, “The Information Content of Implied Volatilities and Model-free Volatility Expectations: Evidence from Options Written on Individual Stocks,” (Paper presented at the annual meeting of the Financial Management Association International, Grapevine, Texas, 8 – 11 October 2008).

### C. Bajlum and Peter Tind Larsen: "Capital Structure Arbitrage: Model Choice and Volatility Calibration"

June 13, 2008

When identifying relative value opportunities across credit and equity markets, the arbitrageur faces two major problems, namely positions based on model misspecification and mismeasured inputs. Using credit default swap data, this paper addresses both concerns in a convergence-type trading strategy. In spite of differences in assumptions governing default and calibration, we find the exact structural model linking the markets second to timely key inputs. Studying an equally-weighted portfolio of all relative value positions, the excess returns are insignificant when based on a traditional volatility from historical equity returns.

### C. Bajlum and P.T. Larsen: "Capital Structure Arbitrage: Model Choice and Volatility Calibration"

June 4, 2008

Deviations from put-call parity contain information about future returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 51 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, a result which cannot be explained by short sales constraints.

### G. Vilkov: "Variance Risk Premium Demystified"

May 8, 2008

We study the dynamics and cross-sectional properties of the variance risk premia embedded in options on stocks and indices, approximated by the synthetic variance swap returns. Several important stylized facts and contributions arise. First, variance risk premia for indices are systematically larger (more negative) than for individual securities. Second, there are systematic cross-sectional differences in the price of variance in individual stocks. Linking variance swaps to firm size/book-to-market, and stock turnover characteristics, an investor gains access to several lucrative long-short strategies with Sharpe Ratios around 2.

### P. Carr and L. Wu: "A Simple Robust Link between American Puts and Credit Insurance"

May 7, 2008

We develop a simple robust link between equity out-of-the-money American put options and a pure credit insurance contract on the same reference company. Assuming that the stock price stays above a barrier B>0 before default but drops and remains below a lower barrier

### P. Santa-Clara and S. Yan: "Crashes, Volatility, and the Equity Premium: Lessons from S&P500 Options"

May 1, 2008

P. Santa-Clara and S. Yan, “Crashes, Volatility, and the Equity Premium: Lessons from S&P500 Options,” (Working paper, Universidade Nova de Lisboa and University of South Carolina, May 2008).

### E. Szado and H. Kazemi: "Collaring the Cube: Protection Options for a QQQ ETF Portfolio"

April 1, 2008

This article assesses the effectiveness of a long collar as a protective strategy. We examine the risk/return characteristics of a passive collar strategy on the Powershares QQQ trust exchange traded fund (Ticker: QQQQ) from March 1999 to March 2008 and find that, over this time period, a 6-month put/1-month call collar provides far superior returns to the buy and hold QQQ strategy at about 1⁄3 of the volatility. Since returns from protective strategies are not normally distributed, we use both Leland alpha and the Stutzer index to measure risk-adjusted performance.

### P. Christoffersen, K. Jacobs, C. Ornthanalai: "Exploring Time-Varying Jump Intensities: Evidence from S&P500 Returns and Options"

March 18, 2008

Existing empirical investigations of jump dynamics in returns and volatility are fairly complicated due to the presence of latent factors. We present a new discrete-time frame-work that combines heteroskedastic processes with rich specifications of jumps in returns and volatility. We provide a tractable risk neutralization framework for this class of mod-els allowing for option valuation with separate modeling of risk premia for the jump and normal innovations. Our models can be estimated with ease on returns using standard maximum likelihood techniques, and joint estimation on returns and a large sample of options is also feasible.

### S. Asmussen, D. Madan, M. Pistorius: "Pricing Equity Default Swaps under an approximation to the CGMY Levy Model"

February 19, 2008

The Wiener-Hopf factorization is obtained in closed form for a phase type approximation to the CGMY Levy process. This allows, for the approximation, exact computation of first passage times to barrier levels via La place transform inversion. Calibration of the CGMY model to market option prices defines the risk neutral process for which we infer the first passage times of stock prices to 30% of the price level at contract initiation.

### E. Bayraktar: "Pricing Options on Defaultable Stocks"

December 21, 2007

We develop stock option price approximations for a model which takes both the risk of default and the stochastic volatility into account. We also let the intensity of defaults be influenced by the volatility. We show that it might be possible to infer the risk neutral default intensity from the stock option prices. Our option price approximation has a rich implied volatility surface structure and fits the data implied volatility well.

### J.S. Doran, D. Jiang, and D.R. Peterson: "Short-Sale Constraints and the Non-January Idiosyncratic Volatility Puzzle"

November 7, 2007

Using event studies, we show that short-sale constraints play an important role in the negative relation between idiosyncratic volatility and stock returns. We explore three exogenous events that change short-sale constraints: the IPO lockup period expiration, option introduction, and the recent short-selling ban on financial stocks. Following mitigation of short-sale constraints from the first two events, high idiosyncratic volatility stocks underperform low volatility stocks in the short and long run, and are associated with higher abnormal trading volume.

institutional

### M. le Roux: "A Long-Term Model of the Dynamics of the S&P500 Implied Volatility Surface"

October 1, 2007

In this paper we present an econometric model of implied volatilities of S&P500 index options. First, we model the dynamics the CBOE VIX index as a proxy for the general level of implied volatilities. We then describe a parametric model of the implied volatility surface for options with a term of up to two years. We show that almost all of the variation in the implied volatility surface can be explained by the VIX index and one or two other uncorrelated factors.

### D. Horn, E. Schneider, and G. Vilkov: "Hedging Options in the Presence of Microstructural Noise"

September 26, 2007

In order to use an option pricing model for dynamic hedging an investor will have to calibrate it to a cross-section of option prices. Microstructural noise in option prices results in a set of indistinguishable parametrizations which may give rise to different hedging errors. In our simulation study for the Heston (1993) model, we identify the parameters most important for hedging and show which set of strikes and time to maturity is relevant for the identification of certain parameters.

### R. Engle and A. Mistry: "Priced Risk and Asymmetric Volatility in the Cross-Section of Skewness"

July 19, 2007

There have been widespread claims that credit derivatives such as the credit default swap (CDS) have lowered the cost of firms’ debt financing by creating for investors new hedging opportunities and information. However, these instruments also give banks an opaque means to sever links to their borrowers, thus reducing lender incentives to screen and monitor. In this paper, we evaluate the effect that the onset of CDS trading has on the spreads that underlying firms pay at issue when they seek funding in the corporate bond and syndicated loan markets.

### E. Eberlein and D.B. Madan: "Sato Processes and the Valuation of Structured Products"

July 3, 2007

We report on the adequacy of using Sato processes to value equity structured products. In models used to price options on realized variance,the latter must be a random variable with a positive variance. An analysis of this variance of realized variance for Sato processes shows that these processes may be suited to option contracts on realized volatility. Nonlinear pricing principles based on hedging to acceptability are outlined for the purpose of pricing structured transactions.

### P. Gagliardini, C. Gourieroux, and E. Renault: "Efficient Derivative Pricing by Extended Method of Moments"

May 1, 2007

This paper extends GMM and information theoretic estimation to settings where the conditional moment restrictions are either uniform (i.e. valid for any value of the conditioning variable), or local (i.e. valid for a particular value of the conditioning variable only). The parameter of interest can be either a structural parameter, or a local conditional moment. This is the framework for option pricing based on both historical data on the underlying asset and cross-sectional data on derivative assets,as a consequence of the rather small traded volumes on derivatives.

### J. Conrad, R.F. Dittmar, and E. Ghysels: "Skewness and the Bubble"

April 16, 2007

Motivated by the Internet bubble in the late 1990’s and early years of this century, we explore the possibility that higher moments of the returns distribution may be important in explaining security returns. Using a sample of option prices from 1996-2005, we estimate individual securities’ volatility, skewness and kurtosis using the method of Bakshi, Kapadia and Madan(2003). We find that higher moments are strongly related to returns, even after controlling for differences in size and book-to-market.

### A. Berndt and A. Ostrovnaya: "Information Flow Between Credit Default Swap, Option and Equity Markets"

March 15, 2007

This paper measures the contribution of the credit default swap (CDS) mar-ket to price discovery relative to equity and equity option markets. We provide a rigorous analysis of whether and to what extent the credit market acquires information prior to the option market, and vice versa. Our results indicate that investors absorb information revealed in the CDS market into option prices within a few days and vice versa. We observe a significant incremental flow of information from CDS to option markets for high-yield firms and following ad-verse earnings announcements.

### V. Di Pietro and G. Vainberg: "Systematic Variance Risk and Firm Characteristics in the Equity Options Market"

December 19, 2006

We construct synthetic variance swap returns from prices of traded options to investigate the pricing of systematic variance risk in the equity options market. Cross sectional tests reveal no evidence of a negative market variance risk premium. Furthermore, we show that a class of linear factor models cannot simultaneously explain index and equity option prices. In particular, equity options appear to be underpriced relative to index options. To exploit the mispricing, we analyze an investment strategy known as dispersion trading, which is implemented by going long a portfolio of equity options, and short a portfolio of index options.

### K. Danquah, S. Kasera, B. Lee, and S. Ung: "Local Volatility Calibration Using the ‘Most Likely Path"

December 19, 2006

Why are we interested in calibrating a local volatility surface? It is mostly to price dependent exotic options which are not very liquid and the proper market quotes are not available. Local volatility also gives rise to some interesting relative value trading strategies. There are a number of local volatility calibration methods available, but no one agrees on the “perfect” calibration method. There is no single correct answer. Perhaps that is the reason why calibration is not only a science but also an art.

### A. Berndt, A. A. Lookman, and I. Obreja: "Default Risk Premia and Asset Returns"

December 18, 2006

This paper investigates the source for common variation in the portion of re-turns observed in U.S. credit markets that is not related to changes in risk free-rates or expected default losses. We extract a latent common component from firm specific changes in default risk premia that is orthogonal to known systematic risk factors during our sample period from 2001 to 2004. Asset pricing tests using returns on Bloomberg-NASD corporate bond indices suggest that our discovered latent changes in default risk premia (DRP) factor is priced in the corporate bond market.

### J. Fan and L. Mancini: "Option Pricing with Aggregation of Physical Models and Nonparametric Statistical Learning"

December 9, 2006

Financial models are largely used in option pricing. These physical models capture several salient features of asset price dynamics. The pricing performance can be significantly enhanced when they are combined with nonparametric learning approaches, that empirically learn and correct pricing errors through estimating state price distributions. In this paper, we propose a new semi-parametric method for estimating state price distributions and pricing financial derivatives. This method is based on a physical model guided non parametric approach to estimate the state price distribution of a normalized state variable, called theAutomatic Correction of Errors (ACE) in pricing formulae.

### G.M. Constantinides, J.C. Jackwerth, and S. Perrakis: "Mispricing of S&P 500 Index Options"

November 10, 2006

We document widespread violations of stochastic dominance by one-month S&P 500 index call options market over 1986-2006. These violations imply that a trader can improve her expected utility by engaging in a zero-net-cost trade. We allow the market to be incomplete and also imperfect by introducing transaction costs and bid-ask spreads. Even though pre-crash option prices conform to the Black-Scholes-Merton model reasonably well, they are incorrectly priced if the distribution of the index return is estimated from time-series data even with a variety of statistical adjustments.

### R. Battalio and P. Schultz: "Options and the Bubble"

October 22, 2006

Many believe that a bubble existed in Internet stocks in the 1999 to 2000 period, and that short-sale restrictions prevented rational investors from driving Internet stock prices to reasonable levels. In the presence of such short-sale constraints, option and stock prices could decouple during a bubble. Using intraday options data from the peak of the Internet bubble, we find almost no evidence that synthetic stock prices diverged from actual stock prices.

### M. Cremers, J. Driessen, and P. Maenhout: "Explaining the Level of Credit Spreads: Option-Implied Jump Risk Premia in a Firm Value Model"

October 19, 2006

Prices of equity index put options contain information on the price of systematic downward jump risk. We use a structural jump-diffusion firm value model to assess the level of credit spreads that is generated by option-implied jump risk premia. In our compound option pricing model, an equity index option is an option on a portfolio of call options on the underlying firm values. We calibrate the model parameters to historical information on default risk, the equity premium and equity return distribution, and S&P 500 index option prices.

### H.S. Choi and N. Jayaraman: "Is Reversal of Large Stock-Price Declines Caused by Overreaction or Information Asymmetry: Evidence from Stock and Option Markets"

July 22, 2006

We reexamine the role of option markets in the reversal process of stock prices following stock price declines of 10 percent or more. We find that the positive rebounds for non-optionable firms are caused by an abnormal increase in bid-ask spread on and before the large price decline date. On the other hand, the bid-ask spreads for optionable firms decrease on and before the large price decline date. We also find an abnormal increase in open interest and volume in the option market on and before the large price decline date.

### G. Bakshi and L. Wu: "Investor Irrationality and the Nasdaq Bubble"

July 22, 2006

This paper investigates whether the rise and fall of the Nasdaq at the turn of the century can be justified by changes in return risk, and whether investors are driven by irrational euphoria with systematic shifts in the market prices of risks (e.g., inexplicable changes in risk aversion and/or subjective probabilities deviating substantially from the objective states of the world). Based on model specification that accommodates fluctuations in both risk levels and market prices of different sources of risks, our analysis provides three new insights.

### E. Zitzewitz: "Price Discovery among the Punters: Using New Financial Betting Markets to Predict Intraday Volatility"

July 19, 2006

The migration of financial betting to prediction market exchanges in the last 5 years has facilitated the creation of contracts that do not correspond to a security traded on a traditional exchange. The most popular of these have been binary options on the closing value of Dow Jones Industrial Average (DJIA). Prices of these options imply expectations of volatility over the very short term, and they can be used to construct an index that has significant incremental predictive power, even after controlling for multiple lags of realized volatility and implied volatility from longer-term options.

### S. De Wachter: "Simple Option Pricing and the Leverage Effect"

December 19, 2005

This paper develops a nonparametric test to investigate whether any of two classes of “simple” models can rationalize observed option prices. These classes are (i) processes with independent returns and (ii) univariate Markov processes. The practice of recalibration is mimicked by only imposing minimal stability requirements on the candidate pricing models. The main finding is that processes with independent returns are inadequate even for the purpose of fitting the cross-section and term-structure on a single day.

### R.B. Evans, C.C. Geczy, D.K. Musto, and A.V. Reed: "Failure is an Option: Impediments to Short Selling and Options Prices"

December 7, 2005

Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. Some of the value of failing passes through to option prices: when failing is cheaper than borrowing, the relation between borrowing costs and option prices is significantly weaker. The remaining value is profit to the market maker, and its ability to profit despite the usual competition between market makers appears to result from a cost advantage of larger market makers at failing.

### A. Saretto: "Option Returns and the Cross-Sectional Predictability of Implied Volatility"

November 1, 2005

I study the cross-section of realized stock option returns and find an economically important source of predictability in the cross-sectional distribution of implied volatility. A zero-cost trading strategy that is long in straddles with a large positive forecast of the change in implied volatility and short in straddles with a large negative forecast produces an economically important and statistically significant average monthly return. The results are robust to different market conditions, to firm risk-characteristics, to various industry groupings, to options liquidity characteristics, and are not explained by linear factor models.

### M.J. Brennan, X. Liu, Y. Xia: "Option Pricing Kernels and the ICAPM"

June 29, 2005

We estimate the parameters of pricing kernels that depend on both aggregate wealth and state variables that describe the investment opportunity set, using FTSE 100 and S&P 500 index option returns as the returns to be priced. The coefficients of the state variables are highly significant and remarkably consistent across specifications of the pricing kernel, and across the two markets. The results provide further evidence that, consistent with Merton’s (1973) Intertemporal Capital Asset Pricing Model, state variables in addition to market risk The failure of simple complete markets option pricing models of the Black-Scholes (1973) type points to the importance in option pricing of state variables other than the underlying asset price.

May 19, 2005

### P. Carr and L. Wu: "Stock Options and Credit Default Swaps: A Joint Framework for Valuation and Estimation"

March 19, 2005

We propose a dynamically consistent framework that allows joint valuation and estimation of stock options and credit default swaps written on the same reference company. We model default as controlled by a Poisson process with a stochastic default arrival rate. When default occurs, the stock price drops to zero. Prior to default, the stock price follows a continuous process with stochastic volatility. The instantaneous default rate and instantaneous diffusion variance rate follow a bivariate continuous Markov process, with its dynamics specified to capture the empirical evidence on stock option prices and credit default swap spreads.

### R. Popovic and D. Goldsman: "An Examination of Forward Volatility"

December 19, 2004

This paper investigates the adequacy of various principal components (p.c.) approaches as data reduction schemes for processing contingent claim valuations on baskets of equities. As a general proposition we are interested in discovering possible features and rules-of-thumb for the applicability of p.c. techniques. In particular, what accuracy does one lose in valuation-hedging schemes as the dimensionality of the p.c. space is reduced? We also have an interest in validating the posted “stylized” facts of implied volatility as they apply to our data sets.

### P. Santa-Clara and A. Saretto: "Option Strategies: Good Deals and Margin Calls"

December 8, 2004

We investigate the risk and return of a wide variety of trading strategies involving options on the S&P 500. We consider naked and covered positions, straddles,strangles, and calendar spreads, with different maturities and levels of money ness.Overall, we find that strategies involving short positions in options generally compensate the investor with very high Sharpe ratios, which are statistically significant even after taking into account the non-normal distribution of returns.Furthermore, we find that the strategies’ returns are substantially higher than warranted by asset pricing models.

### R. Sen: "Modeling the Stock Price Process as a Continuous Time Jump Process"

June 19, 2004

An important aspect of the stock price process, which has of ten been ignored in the nancial literature, is that prices on organized exchanges are restricted to a grid. We consider continuous-time models for the stock price process with random waiting times of jumps and discrete jump size. We consider a class of jump processes that are close “to the Black-Scholes model in the sense that as the jump size goes to zero, the jump model converges to geometric Brownianmotion.

### J. Pan and A.M. Poteshman: "The Information in Option Volume for Stock Prices"

September 4, 2003

We find strong evidence that option trading volume contains information about future stock price movements. Taking advantage of a unique dataset from the ChicagoBoard Options Exchange, we construct put to call ratios for underlying stocks, using volume initiated by buyers to open new option positions. Performing daily cross-sectional analyses from 1990 to 2001, we find that buying stocks with low put/call ratios and selling stocks with high put/call ratios generates an expected return of 40basis points per day and 1 percent per week.

### E. Ofek, M. Richardson, and R.F. Whitelaw: "Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets"

January 3, 2003

We investigate empirically the well-known put–call parity no-arbitrage relation in the presence of short sales restrictions. Violations of put–call parity are asymmetric in the direction of short sales constraints, and their magnitudes are strongly related to the cost and difficulty of short selling. These violations are also related to both the maturity of the option and the level of valuations in the stock market, consistent with a behavioral finance theory of over-optimistic stock investors and market segmentation.

### P. Carr and L. Wu: "Static Hedging of Standard Options"

November 12, 2002

We consider the hedging of options when the underlying assetprice is exposed to the possibility ofjumps of random size. Working in a single factor Markovian setting, we derive a new, static spanningrelation between a given option and a continuum of shorter-term options written on the same asset.We implement this static relation using a finite set of shorter-term options and use Monte Carlosimulation to determine the hedging error. We compare this hedging error to that of a delta hedgingstrategy based on daily rebalancing in the underlying futures.

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### D. Hait: "Dividend Forecasts, Option Pricing Models, and Implied Volatility Calculations: Why Simpler is Better"

March 1, 2001

For the purposes of calculating option prices or implied volatilities, the use of a dividend forecasting model based on projected actual dividend growth rates can lead to an option model which is internally inconsistent. In contrast, the use of a model based on constant dividend yields is not only consistent, but also easier to implement. Regardless of the method of handling future dividend payments, any associated errors in the forecast dividend rate will in general result have only a small impact on calculated option implied volatilities, even for long-dated options.

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