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Risk-Neutral Skewness: Evidence from Stock Options

Published online by Cambridge University Press:  06 April 2009

Patrick Dennis  and
Stewart Mayhew
Patrick Dennis
Affiliation:
pjd9v@virginia.edu, McIntire School of Commerce, University of Virginia, Charlottesville, VA 22903
Stewart Mayhew
Affiliation:
mayhew@terry.uga.edu, Department of Banking and Finance, Terry College of Business, University of Georgia, Athens, GA 30602.
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Abstract

We investigate the relative importance of various factors in explaining the volatility skew observed in the prices of stock options traded on the Chicago Board Options Exchange. The skewness of the risk-neutral density implied by individual stock option prices tends to be more negative for stocks that have larger betas, suggesting that market risk is important in pricing individual stock options. Also, implied skewness tends to be more negative in periods of high market volatility, and when the risk-neutral density for index options is more negatively skewed. Other firm-specific factors, including firm size and trading volume a so help explain cross-sectional variation in skewness. However, we find no robust relationship between skewness and the firm's leverage. Nor do we find evidence that skewness is related to the put/call ratio, which may be viewed as a proxy for trading pressure or market sentiment. Overall, firm-specific factors seem to be more important than systematic factors in explaining the variation in the skew for individual firms.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 37 , Issue 3 , September 2002 , pp. 471 - 493
Copyright
Copyright © School of Business Administration, University of Washington 2002

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