Fear or greed? What does a skewness index measure?

The ℎ ℎ (CBOE) SKEW index is designed to capture investors’ fear in the US stock market. In this paper we pursue two objectives. First, we investigate the properties of the CBOE SKEW index in order to assess whether it captures fear or greed in the market. Second, we introduce and compare three measures of asymmetry of the Italian index options return distribution. These measures include: (i) the CBOE SKEW index adapted to the Italian market (we call it ITSKEW) and (ii) two model-free measures of skewness based on comparison of a bear and a bull index. Finally, we explore the existence and sign of the skewness risk premium. Several results are obtained. First, the Italian skewness index (ITSKEW) presents many advantages compared to the two model-free measures: it has a significant contemporaneous relation with market index returns and with model-free implied volatility. Both the ITSKEW and the CBOE SKEW indices act as measures of market greed (the opposite of market fear), since returns react positively to an increase in the skewness indices. Trading strategies show that the Italian market is characterized by a significant positive skewness risk premium

Moment Risk Premia and the Cross-Section of Stock Returns

The aim of this paper is to assess the existence and the sign of moment risk premia. To this end, we use methodologies ranging from swap contracts to portfolio sorting techniques in order to obtain robust estimates. We provide empirical evidence for the European stock market for the 2008-2015 time period. Evidence is found of a negative volatility risk premium and a positive skewness risk premium, which are robust to the different techniques and cannot be explained by common risk-factors such as market excess return, size, book-to-market and momentum. Kurtosis risk is not priced in our dataset. Furthermore, we find evidence of a positive risk premium in relation to the firm’s size

Towards a skewness index for the Italian stock market

The present paper is a first attempt of computing a skewness index for the Italian stock market. We compare and contrast different measures of asymmetry of the distribution: an index computed with the CBOE SKEW index formula and two other asymmetry indexes, the SIX indexes, as proposed in Faff and Liu (2014). We analyze the properties of the skewness indexes, by investigating their relationship with model-free implied volatility and the returns on the underlying stock index. Moreover, we assess the profitability of skewness trades and disentangle the contribution of the left and the right part of the risk neutral distribution to the profitability of the latter strategies. The data set consists of FTSE MIB index options data and covers the years 2011-2014, allowing us to address the behavior of skewness measures both in bullish and bearish market periods. We find that the Italian SKEW index presents many advantages with respect to other asymmetry measures: it has a significant contemporaneous relation with both returns, model-free implied volatility and has explanatory power on returns, after controlling for volatility. We find a negative relation between volatility changes and changes in the Italian SKEW index: an increase in model-free implied volatility is associated with a decrease in the Italian SKEW index. Moreover, the SKEW index acts as a measure of market greed, since returns react more negatively to a decrease in the SKEW index (increase in risk neutral skewness) than they react positively to an increase of the latter (decrease in risk neutral skewness). The results of the paper point to the existence of a skewness risk premium in the Italian market. This emerges both from the fact that implied skewness is more negative than physical one in the sample period and from the profitability of skewness trading strategies. In addition, the higher performance of the portfolio composed by only put options indicates that the mispricing of options is mainly focused on the left part of the distribution

Forecasting and pricing powers of option-implied tree models: Tranquil and volatile market conditions

The aims of this paper are twofold. First, to investigate the accuracy of different option-implied trees in pricing European options in order to assess the power of implied trees in replicating the market information. Second, to compare deterministic volatility implied trees and stochastic implied volatility models (Bakshi et al. (2003)) in assessing the forecasting power of implied moments on subsequently realised moments, and ascertaining the existence, magnitude and sign of variance, skewness, and kurtosis risk-premia. The analysis is carried out using the Italian daily market data covering the period 2005-2014. This enables us to contrast the pricing performance of implied trees and to assess the magnitude and sign of risk premia in both a tranquil and a turmoil period. The findings are as follows. First, the pricing performance of the Enhanced Derman and Kani (EDK, Moriggia et al. 2009) model is superior to that of the Rubinstein (1994) model. This superiority is stronger especially in the high volatility period due to a better estimation of the left tail of the distribution describing bad market conditions. Second, the Bakshi et al. (2003) formula is the most accurate for forecasting skewness and kurtosis, while for variance it yields upwardly biased forecasts. All models agree on the signs of the risk premia: negative for variance and kurtosis, and positive for skewness, but differ in magnitude. Overall, the results suggest that selling (buying) variance and kurtosis (skewness) is profitable in both high and low volatility periods

The properties of a skewness index and its relation with volatility and returns

The objective of this study is threefold. First, we investigate the properties of a skewness index in order to determine whether it captures fear (fear of losing money), or greed in the market (fear of losing opportunities). Second, we uncover the combined relationship among skewness, volatility and returns. Third, we provide further evidence and possible explanations for the relationship between skewness and future returns, which is highly debated in the literature. The stock market investigated is the Italian one, for which a skewness index is not traded yet. The methodology proposed for the construction of the Italian skewness index can be adopted for other European and non-European countries characterized by a limited number of option prices traded. Several results are obtained. First, we find that in the Italian market the skewness index acts as measures of market greed, as opposed to market fear. Second, for almost 70% of the daily observations, the implied volatility and the skewness index move together but in opposite directions. Increases (decreases) in volatility and decreases (increases) in the skewness index are associated with negative (positive) returns. Last, we find strong evidence that positive returns are reflected both in a decrease in the implied volatility index and in an increase in the skewness index the following day. Implications for investors and policy makers are drawn

Return and Volatility Spillover among Banks and Insurers: Evidence from Pre-Crisis and Crisis Periods

We investigate the return and volatility interdependencies among the US, the UK, the EU, and Japanese banks and insurers during the period of 2003 to 2009. We find strong return and volatility transmissions within and across banking and insurance industries, strengthened contagious spillover effects during the crisis of 2007 to 2009, and a leading role played by the US financial institutions as information providers in global markets. Furthermore, we find that firm characteristics such as size and leverage drive the interdependencies among major banking firms. Our findings have important implications for effective hedging and diversification strategies, asset pricing and risk management, and the formulation of regulatory and monetary policies

Banks’ equity performance and the term structure of interest rates

Using an extensive global sample, this paper investigates the impact of the term structure of interest rates on bank equity returns. Decomposing the yield curve to its three constituents (level, slope and curvature), the paper evaluates the time-varying sensitivity of the bank’s equity returns to these constituents by using a diagonal dynamic conditional correlation multivariate GARCH framework. Evidence reveals that the empirical proxies for the three factors explain the variations in equity returns above and beyond the market-wide effect. More specifically, shocks to the long-term (level) and short-term (slope) factors have a statistically significant impact on equity returns, while those on the medium-term (curvature) factor are less clear-cut. Bank size plays an important role in the sense that exposures are higher for SIFIs and large banks compared to medium and small banks. Moreover, banks exhibit greater sensitivities to all risk factors during the crisis and postcrisis periods compared to the pre-crisis period; though these sensitivities do not differ for market-oriented and bank-oriented financial systems

Do the home field, global advantage, and liability of unfamiliarness hypotheses hold? empirical evidence from Malaysia

The study explores the home field, global advantage, and liability of unfamiliarness hypotheses in the Malaysian banking sector. The results indicate that Malaysian banks have exhibited productivity progress mainly attributed to technological progress. The authors find negative relationship between foreign and government ownership and bank productivity. Likewise, the publicly listed banks have been relatively less productive compared to private banks, thus rejecting the market discipline hypothesis. The empirical findings suggest that foreign banks from the North American countries to be the least productive banking group lending support to the home field advantage and the limited form of the global advantage hypotheses