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date: 20 November 2019

Abstract and Keywords

This article deals with the informational content of market option prices and focuses on studies that are primarily concerned with the use of option-implied information in the context of quantitative asset management. A study undertaken by Xing, Zhang, and Zhao, focuses on the predictability of slope, of implied volatility smirk. Robustness checks indicate that after controlling for the predictive ability of known variables such as the difference between the historical and implied volatility, the historical volatility of stocks, and the put-call call ratio, and the predictive power of the skew is still economically large and statistically significant. A subsequent study by Rehman and Vilkov uses the Bakshi, Kapadia, and Madan model-free measure to explore the stock-specific information content of the option price cross-sections. This measure captures the skewness of a stock's risk-neutral return distribution. Cremers and Weinbaum hypothesize that deviations from put-call parity in options on individual stocks may reflect the trading activity of informed investors who trade first in the option markets and subsequently in the stock markets. Bali and Hovakimian test whether there is a negative cross-sectional relation between firm-level returns and the volatility risk premium. The empirical evidence of a negative volatility risk premium motivates their hypothesis. Doran and Krieger study the information content of different parts of the implied volatility skew.

Keywords: quantitative asset management, volatility risk premium, implied volatility skew, hedge portfolio, equity long/short portfolio strategies

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