TAILIEUCHUNG - STOCK RETURN CHARACTERISTICS, SKEW LAWS, AND THE DIFFERENTIAL PRICING OF INDIVIDUAL EQUITY OPTIONS

In Table 3, we summarize the findings of this section. In each row of the table, we list the source and coverage of the data, the information available — either the market values or the price-earnings ratios — and our estimate of the total market value of all . companies relative to GNP. As we noted earlier, the estimate we believe to be the most reliable is Sloan’s (1936), which implies a total market value of times GNP. But this estimate lies between the higher estimates based on S&P companies and the lower estimates of Fisher (1930), Jovanovic and Rousseau (2001), and that based on. | Stock Return Characteristics Skew Laws and the Differential Pricing of Individual Equity Options Gurdip Bakshi University of Maryland Nikunj Kapadia University of Massachusetts-Amherst Dilip Madan University of Maryland This article provides several new insights into the economic sources of skewness. First we document the differential pricing of individual equity options versus the market index and relate it to variations in return skewness. Second we show how risk aversion introduces skewness in the risk-neutral density. Third we derive laws that decompose individual return skewness into a systematic component and an idiosyncratic component. Empirical analysis of OEX options and 30 stocks demonstrates that individual riskneutral distributions differ from that of the market index by being far less negatively skewed. This article explains the presence and evolution of risk-neutral skewness over time and in the cross section of individual stocks. Skewness continues to occupy a prominent role in equity markets. In the traditional asset pricing literature stocks with negative coskewness command a higher equilibrium risk compensation see Rubinstein 1973 and the empirical applications in Kraus and Litzenberger 1976 and Harvey and Siddique 2000 . Realizing the inherent importance of skewness Merton 1976 Rubinstein 1994 Bakshi Cao and Chen 1997 Ait-Sahalia and Lo 1998 Madan Carr and Chang 1998 Pan 1999 Bates 2000 and We acknowledge discussions on this topic with Yacine Ait-Sahalia Torben Anderson Meghana Ayyagari Warren Bailey Ravi Bansal David Bates Nick Bollen Peter Carr Charles Cao Henry Cao Zhiwu Chen George Chacko Amy Chan Dave Chapman Alex David Darrell Duffie Rob Engle Rene Garcia Eric Ghysels John Guo Levent Guntay Hua He Mike Hemler Harrison Hong Ming Huang Jon Ingersoll Bob Jarrow Nengjiu Ju Hossein Kazemi Inanc Kirgiz Haitao Li Nour Meddahi Maureen O Hara Jun Pan Gurupdesh Pande Nagpurnanand Prabhala Chandrasekhar Reddy Gokhul Eric Renault Lemma Senbet Paul .

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