Research

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.