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Jump Risk, Stock Returns, and Slope of Implied Volatility Smile ∗

By Shu Yan, I Thank Anurag Gupta, Michael Lemmon, Roger Loh, Francis Longstaff, Steve Mann and Pedro Santa-clara


Under the jump-diffusion framework, expected stock return is dependent on the average jump size of stock price, which can be inferred from the slope of option implied volatility smile. This implies a negative relation between expected stock return and slope of implied volatility smile, which is strongly supported by the empirical evidence. For over 4,000 stocks ranked by slope of implied volatility smile during 1996 – 2005, the difference between average returns of the lowest and highest quintile portfolios is 22.2 % per year. The findings cannot be explained by risk factors like RM − Rf, SMB, HML, and MOM; or by stock characteristics like size, book-to-market, leverage, volatility, skewness, and volume

Topics: Key words, Jump risk, Stock returns, Options, Implied volatility smile, Slope1 Introduction
Year: 2008
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