Date of Completion
4-10-2018
Embargo Period
4-6-2028
Major Advisor
Paul Borochin
Associate Advisor
Carmelo Giaccotto
Associate Advisor
Joseph Golec
Associate Advisor
Yangru Wu
Field of Study
Business Administration
Degree
Doctor of Philosophy
Open Access
Open Access
Abstract
This dissertation consists of three essays on eliciting information about underlying assets from the equity options markets, and improving our understanding of the term structure cost of equity.
In the first essay, we find that high standard deviations of the volatility premium, of implied volatility innovations, and of the volatility term structure spread in equity options predict low underlying returns. This return predictability is not explained by the levels of these three variables, or by volatility of volatility, other known firm characteristics, or common risk factor models. We find support for interpreting the standard deviations of these option-based measures as forward-looking proxies of heterogeneous beliefs.
In the second essay, we find that stocks with high risk-neutral skewness (RNS) exhibit abnormal performance driven by rebounds following poor performance. This behavior connects it to momentum crashes caused by reversal in past losers. In periods of post-recession rebounds and high market volatility when momentum crashes occur, a zero-investment high-low RNS portfolio has significant positive abnormal returns. The momentum anomaly is strongest (weakest) in stocks with the lowest (highest) RNS, consistent with the positive relationship of RNS to momentum crashes. These results hold controlling for trading frictions, other firm characteristics, and risk factors. We generalize our findings to all stocks by constructing an RNS factor-mimicking portfolio SKEW and find that a WML strategy that avoids high SKEW beta stocks has superior performance to the baseline and risk-managed WML strategies.
In the third essay, we estimate the cost of equity capital term structure for the insurance industry as a whole, and several insurance sectors such as life/health and property/casualty. We use a vector autoregressive process to jointly model the dynamics of expected cash flows, beta, and the market risk premium. We obtain a closed form solution for the discount rate appropriate for each maturity. Our empirical analysis shows that for the insurance industry, the cost of equity based on our term structure model is on average nearly 299.6 basis points higher compared to the single period CAPM. This means that these insurers might overly invest if they rely on the single period CAPM.
Recommended Citation
Zhao, Yanhui, "Option Markets, Return Predictability and Term Structure" (2018). Doctoral Dissertations. 1765.
https://digitalcommons.lib.uconn.edu/dissertations/1765