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Predictable Dynamics in Higher-Order Risk-Neutral Moments: Evidence from the S&P 500 Options

Published online by Cambridge University Press:  18 June 2013

Michael Neumann  and
George Skiadopoulos
Michael Neumann
Affiliation:
[email protected], School of Economics and Finance, Queen Mary, University of London, 327 Mile End Rd, London E1 4NS, UK
George Skiadopoulos
Affiliation:
[email protected], Department of Banking and Financial Management, University of Piraeus, Karaoli and Dimitriou 80, Piraeus 18534, Greece, and Queen Mary, University of London, UK, and City University London, UK
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Abstract

We investigate whether there are predictable patterns in the dynamics of higher-order risk-neutral moments (RNMs) extracted from the market prices of Standard & Poor’s (S&P) 500 index options. To this end, we conduct a horse race among alternative forecasting models within an out-of-sample context over various forecasting horizons. We consider both a statistical and an economic setting. We find that higher RNMs can be statistically forecasted. However, only the 1-day-ahead skewness forecasts can be economically exploited. This economic significance vanishes once we incorporate transaction costs. The results have implications for the dynamics of implied volatility surfaces.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 48 , Issue 3 , June 2013 , pp. 947 - 977
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2013 

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