Workshop Programme

Friday 18 June

Room: Trent 236, UNNC

Session Chair: Xiaoquan Liu (University of Nottingham Ningbo China)

1.30pm

Option implied ambiguity and equity return

Xianming Sun (Zhongnan University of Economics and Law)

Yanni Chen (Zhongnan University of Economics and Law)

Discussant: Lijun Bo (University of Science and Technology of China, online)

2.45pm

Firm fundamentals and the cross-section of implied volatility shapes

Ding Chen (University of Sussex)

Biao Guo (Renmin University)

Guofu Zhou (Washington University in St. Louis)

Discussant: Ke Tang (Tsinghua University)

Tea Break

4.20pm

Probability weighting and commodity futures returns

Qi Xu (Zhejiang University)

Ying Wang (Zhejiang University)

Yunzhu Shi (Shanghai Jiaotong University)

Discussant: Wenjin Kang (Shanghai University of Finance and Economics)

6pm

Dinner

8pm

Meeting for members of the China Derivatives Youth Forum

Saturday 19 June

Room: Trent 236, UNNC

Session Chair: Rong Chen (Xiamen University, online)

8.20am

Crowding and factor returns

Wenjin Kang (Shanghai University of Finance and Economics)

Geert Rouwenhorst (Yale University)

Ke Tang (Tsinghua University)

Discussant: Xiaohui Gao Bakshi (Temple University, online)

9.35am   

Out-of-sample equity premium prediction: The role of option-implied constraints

Yunqi Wang (Southern University of Science and Technology)

Ti Zhou (Southern University of Science and Technology)

Discussant: Guofu Zhou ( University of Washington in St. Louis, online)

Tea Break

11am

Information flow between stock and options markets: Evidence from real-time corporate news

Xugan Chen (Yale University)

Tse-Chun Lin (Hong Kong University)

Xingguo Luo (Zhejiang University)

Discussant: Avanidhar Subrahmanyam (UCLA, online)

12pm

Dinner

Summary of Abstracts

Firm fundamentals and the cross-section of implied volatility shapes

Ding Chen, Biao Guo, Guofu Zhou

We investigate whether firm fundamentals can explain the shape of the option implied volatility (IV) curve. Extending Geske's (1997) compound option model, we link firm fundamentals to the prices of equity and equity options and show how the shape of the IV curve can vary across firms with leverage, dividend policy, cost of capital, and so on. Using options of all available US-listed companies, we empirically show that firm fundamentals are important determinants of the IV curve even after controlling for historical volatility, risk-neutral skewness, kurtosis and systematic risk ratio, especially for the volatility slopes and curvatures. Fundamentals provide statistically and economically explanatory power on the IV curve and reconcile with stylized facts and puzzles.

Option implied ambiguity and equity return

Xianming Sun, Yanni Chen

We propose an option-implied ambiguity measure to capture uncertainty about the return distribution of a risky asset underlying a set of options and investigate its predictive power for the asset return. This new measure is calculated in two key steps: firstly, the intra-day return distributions over a future time period are extracted from the options' prices with a model-guided approach; secondly, option-implied ambiguity is derived from these return distributions in a similar line with Brenner & Izhakian (2018). The proposed measure could separate the strength of distribution uncertainty from an investor' attitude towards ambiguity. Such property allows us to empirically investigate how ambiguous return and investors' attitude jointly affect the risky asset price. Consistent with the behavioural research on the state-dependent attitude towards ambiguity, our results show that investors exhibit ambiguity aversion when experiencing favourable return and vice versa. Moreover, the out-of-sample tests show that the option-implied ambiguity has the predictive power for the future returns of the underlying asset. 

Probability weighting and commodity futures returns

Qi Xu, Ying Wang, Yunzhu Shi

We empirically investigate the effect of probability weighting on the cross-section of commodity futures returns. High probability weighting value commodities significantly underperform their low-value pairs by 11% per annum. The predictability cannot be attributed to existing commodity risk factors or characteristics. Including the new long-short strategy along with existing commodity portfolios significantly improves the diversification benefits of asset allocation. The predictability is more pronounced when arbitrage constraints are more binding. Moreover, high probability weighting value commodities attract excess demand of non-commercial traders. These findings are consistent with the mispricing explanation. Comprehensive robustness checks support our main findings.

Crowding and factor returns

Wenjin Kang, Geert Rouwenhorst, Ke Tang

This paper documents that crowding by market participants affects the expected return to popular factor strategies such as value, momentum, and carry. Using data published by the CFTC for commodity futures markets, we construct a direct measure of factor strategy crowding based on the aggregate positioning of market participants. We show that this crowding measure has a strong negative predictive impact on expected factor strategy returns. Historical factor strategy returns are accumulated primarily during periods of low crowding. We link variation in our crowding measure to macroeconomic fundamentals and suggest that the reduction of factor strategy returns is related to variation in the cost of arbitrage capital.

Out-of-sample equity premium prediction: The role of option-implied constraints

Yunqi Wang, Ti Zhou

We propose a new constrained equity premium forecasting approach that incorporates two option-implied lower bounds on the conditional market premium by Martin (2017) and Chabi-Yo and Loudis (2020), respectively. Specifically, we truncate the forecasts whenever they fall below the implied lower bounds. Our constrained approach delivers considerable out-of-sample gains in both statistical and economic criteria relative to the unconstrained predictive regression and the forecast combination method. Even stronger performance is uncovered when the upper bound on equity premium by Chabi-Yo and Loudis (2020) is incorporated. Compared to the prevailing non-negativity constraint on equity premium forecasts, our method leads to more substantial improvements, especially at the longer forecast horizons. We provide two explanations for the superiority of our method: (i) constrained forecasts to combine the information provided by conventional predictors and the forward-looking information about the term structure of expected holding period returns implied by options prices; (ii) option implied bounds sharpen the unconstrained forecasts and significantly reduce the forecast variance at the same time.

Information flow between stock and options markets: Evidence from real-time corporate news

Xugan Chen, Tse-Chun Lin, Xingguo Luo

Utilizing high-frequency signed options volume and real-time corporate news data, we show that the first 10-minute options order imbalance predicts daily stock returns. The predictability is much stronger on days with non-scheduled corporate news being released during the trading hours, indicating that options traders possess private information regarding forthcoming corporate news content. The return predictability is also higher on days with the news being released before the market opening, indicating that options investors have superior abilities to process public information. Overall, our results suggest that information, both private and processes, flows from the options market to the stock market at the intraday level.