@article{3b9122a9054844b4a3c2c89ec57080ee,
title = "Cross section of option returns and idiosyncratic stock volatility",
abstract = "This paper presents a robust new finding that delta-hedged equity option return decreases monotonically with an increase in the idiosyncratic volatility of the underlying stock. This result cannot be explained by standard risk factors. It is distinct from existing anomalies in the stock market or volatility-related option mispricing. It is consistent with market imperfections and constrained financial intermediaries. Dealers charge a higher premium for options on high idiosyncratic volatility stocks due to their higher arbitrage costs. Controlling for limits to arbitrage proxies reduces the strength of the negative relation between delta-hedged option return and idiosyncratic volatility by about 40%.",
keywords = "Idiosyncratic volatility, Limits to arbitrage, Market imperfections, Option return",
author = "Jie Cao and Bing Han",
note = "Funding Information: We thank our editor (Bill Schwert) and referee (Stephen Figlewski) for many helpful comments and insightful suggestions. We also thank Henry Cao, Andrea Frazzini, John Griffin, Jingzhi Huang, Joshua Pollet, Harrison Hong, Jonathan Reeves, Alessio Saretto, Sheridan Titman, Stathis Tompaidis, Grigory Vilkov, Chun Zhang, Yi Zhou, and seminar participants at Chinese University of Hong Kong, Tsinghua University, and University of Texas at Austin for helpful discussions. We have benefited from the comments of participants at the 2012 annual meetings of the American Finance Association, Fourth Annual Conference on Advances in the Analysis of Hedge Fund Strategies, 20th Annual FDIC Derivatives Securities and Risk Management Conference, 2011 Financial Intermediation Research Society Conference, 6th International Conference on Asia-Pacific Financial Markets at Seoul, 2010 National Taiwan University International Conference, Quantitative Methods in Business Conference at Peking University, and Second Shanghai Winter Finance Conference. The work described in this paper was partially supported by a grant from the Research Grant Council of the Hong Kong Special Administrative Region , China (Project No. CUHK 440410 ). ",
year = "2013",
month = apr,
doi = "10.1016/j.jfineco.2012.11.010",
language = "English",
volume = "108",
pages = "231--249",
journal = "Journal of Financial Economics",
issn = "0304-405X",
publisher = "Elsevier B.V.",
number = "1",
}