Market Skewness Risk, Risk Aversion and the Cross-Section of Stock Returns

E-print/Working paper (2018)

Previous research suggests that the cross section of stock returns has substantial exposure to risks captured by higher moments of market returns, implied by S&P500 index option prices. However, assuming ... [more ▼]

Previous research suggests that the cross section of stock returns has substantial exposure to risks captured by higher moments of market returns, implied by S&P500 index option prices. However, assuming that risk aversion is time-varying, a risk-based explanation would suggest that the exposure is priced in periods of high risk aversion, while it is not necessarily priced/weaker in periods of low risk aversion. We find that for market skewness and kurtosis, this hypothesis is not supported by the data. We find that each of the higher moment prices of risk is time-varying and has significantly different patterns under different market conditions, proxied by a measure of investors’ relative risk aversion. In particular, in line with our reasoning, our results suggest that only in down-markets (high risk aversion periods), the exposure to the market volatility innovations is priced significantly negative in the cross-section of stocks, while it is not priced in up-markets (low risk aversion periods). In contrast, we find that in down-markets, market skewness and kurtosis are not priced risk factors, while the price of market skewness risk is significantly negative and the price of kurtosis risk is positive in up-markets. However, the previously reported results for skewness and kurtosis are counterintuitive, strictly violate the risk compensation principles and, therefore, do not support a risk-based explanation. The results persist even after controlling for the Fama-French and Carhart factors. [less ▲]

Data Filtering Rules in Option Valuation

E-print/Working paper (2018)

The choice of data filtering rules are, next to model selection and parameter calibration, an important step in an option pricing exercise. We illustrate the implications of data filtering rules, by ... [more ▼]

The choice of data filtering rules are, next to model selection and parameter calibration, an important step in an option pricing exercise. We illustrate the implications of data filtering rules, by investigating three alternative renowned filtering rules in the context of pricing European S&P 500 index options. Different filtering rules result in strongly diverging samples, which carry different information and therefore lead to different parameter estimates. This is illustrated for the Ad Hoc Black-Scholes model. No filtering rule is, in terms of pricing performance, superior on the whole range of options. Instead, each filtering rule is specialized toward better pricing of options types that were included in the calibration sample at the costs of excluded options. Included options are unable to perfectly represent the properties and characteristics of excluded options. In particular, option prices are heterogeneous in the maturity dimension, which is a major driving force underlying the impact of exclusion filters on pricing performance. Additionally, small deviations from the put-call parity strongly affect parameter estimates as well as the accompanying pricing performance. These results emphasize the prominent role of filtering rules as an important implicit choice for an option pricing model calibration. [less ▲]

Trade Credit and firm Comovements

E-print/Working paper (2015)

This paper provides evidence that production linkages, as well as credit chains (represented by trade credit), are important for the transmission of idiosyncratic (firm-level) shocks across firms in the ... [more ▼]

This paper provides evidence that production linkages, as well as credit chains (represented by trade credit), are important for the transmission of idiosyncratic (firm-level) shocks across firms in the economy. We build on the idea that trade credit develops along production linkages, and amplifies the idiosyncratic shock as firms may lack inputs and also liquidity. Using disaggregated firm-level data we show that the disturbance of customer's sales increases with greater trade credit linkage. We show that during a recession the existence of trade credit linkage propagates shocks upstream, from a supplier onto its upstream customer. In these periods, firms are short of liquidity and are unable to withstand a drop in trade credit provision. In good times, however, trade credit plays a stabilizing role, reducing the volatility of firms' sales. In these periods, firms with sufficient liquidity are able to transfer some of it to liquidity-starved production partners in order to guarantee their own stable production. [less ▲]

The Impact of Uncertainty in the Oil and Gold Market on the Cross-Section

E-print/Working paper (2015)

Ripple Effects from Industry Defaults

E-print/Working paper (2014)

Modeling default correlation in a US retail loan portfolio

E-print/Working paper (2012)