Cross section of option returns and idiosyncratic stock volatility

Jie Cao, Bing Han

Research output: Journal article publicationJournal articleAcademic researchpeer-review

90 Citations (Scopus)

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%.

Original languageEnglish
Pages (from-to)231-249
Number of pages19
JournalJournal of Financial Economics
Volume108
Issue number1
DOIs
Publication statusPublished - Apr 2013
Externally publishedYes

Keywords

  • Idiosyncratic volatility
  • Limits to arbitrage
  • Market imperfections
  • Option return

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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