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Asset Pricing: What We Can Learn From Derivatives

Paper Session

Sunday, Jan. 7, 2018 10:15 AM - 12:15 PM

Loews Philadelphia, Commonwealth Hall A1
Hosted By: American Finance Association
  • Chair: Travis Johnson, University of Texas-Austin

Understanding Returns to Short Selling Using Option-Implied Stock Borrowing Fees

Dmitriy Muravyev
,
Boston College
Neil Pearson
,
University of Illinois-Urbana-Champaign
Joshua Pollet
,
University of Illinois-Urbana-Champaign

Abstract

Readily available measures of short selling and stock borrowing activity predict stock returns. It is difficult to identify the source of this return predictability. We partially resolve the puzzle by using portfolio sorts and measures of the stock borrowing costs paid by short-sellers to show that the returns to short selling net of stock borrowing costs are less than one-third of the gross returns to a typical strategy, and not significant. Option-implied borrowing fees, which reflect option market makers’ borrowing costs and the risks of changes in those costs, are on average equal to quoted borrowing fees. This finding indicates that the risk of changes in borrowing fees is not systematically priced. Option-implied borrowing fees predict stock returns, including returns net of quoted borrowing costs. The option-implied fee drives out other return predictors in panel regressions.

Does the Ross Recovery Theorem Work Empirically?

Jens Jackwerth
,
University of Konstanz
Marco Menner
,
University of Konstanz

Abstract

Starting with the fundamental relationship that state prices are the product of physical probabilities and the pricing kernel, Ross (2015) shows that, given strong assumptions, knowing state prices suffices for backing out physical probabilities and the pricing kernel at the same time. We find that such recovered physical distributions based on the S&P 500 index are incompatible with future realized returns. This negative result remains, even when we add economically reasonable constraints. Reasons for the rejection seem to be numerical instabilities of the recovery algorithm and the inability of the constrained versions to generate pricing kernels sufficiently away from risk-neutrality.

Margin Requirements and Equity Option Returns

Steffen Hitzemann
,
Ohio State University
Michael Hofmann
,
Karlsruhe Institute of Technology
Marliese Uhrig-Homburg
,
Karlsruhe Institute of Technology
Christian Wagner
,
Copenhagen Business School

Abstract

In equity option markets, traders face margin requirements both for the options themselves and for hedging-related positions in the underlying stock market. We show that these requirements carry a significant margin premium in the cross-section of equity option returns. The sign of the margin premium depends on demand pressure: If end-users are on the long side of the market, option returns decrease with margins, while they increase otherwise. Our results are statistically and economically significant and robust to different margin specifications and various control variables. We explain our findings by a model of funding-constrained derivatives dealers that require compensation for satisfying end-users' option demand.
Discussant(s)
Adam Reed
,
University of North Carolina-Chapel Hill
Bjorn Eraker
,
University of Wisconsin-Madison
Robert Battalio
,
University of Notre Dame
JEL Classifications
  • G1 - General Financial Markets