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G. Bakshi, J. Crosby, X. Gao, J. Xue and W. Zhou: The Options-Inferred Equity Premium and the Slippery Slope of The Negative Correlation Condition

January 15, 2025

The negative correlation condition (NCC) of Martin (2017) is that cov P t (M T R T , R T) ≤ 0 for all M T , where M T is the SDF and R T is the gross market return. He employs this assumption to derive a lower bound of the equity premium. This paper exploits theoretical and empirical constructions to refute the hypothesis of the NCC. Using options on the S&P 500 index and STOXX 50 equity index, our tests favor rejection. Our empirical counterexamples of M T contradict the universality of the NCC, exhibit variance-dependence and incorporate an increasing region to the return upside.

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