CFR-Working Paper NO . 09-11 Cross-sectional analysis of risk-neutral skewness

We investigate the association of various firm-specific and market-wide factors with the riskneutral skewness (RNS) implied by the prices of individual stock options. Our analysis covers 149 U.S. firms over a four-year period. Our choice of firms is based on adequate liquidity and trading interest across different strike prices in the options market, ensuring economically meaningful RNS estimates. We also incorporate significant methodological enhancements. Consistent with earlier results, we find that the RNS of individual firms varies significantly and negatively with firm size, firm systematic risk, and market volatility; and significantly and positively with the RNS of the market index; and most of the variation in individual RNS is explained by firm-specific rather than market-wide factors. We also document several interesting new results that are clearly unambiguous and significantly stronger than in earlier work, or opposite to earlier evidence, or for variables that have been examined for the first time. First, we find that market sentiment has a negative and significant effect on RNS. Second, we find that higher a firm’s own volatility, the more negative the RNS, a relationship that is in the same direction as for overall market volatility. Third, greater market liquidity is associated with more negative RNS, but the liquidity that is relevant for RNS is that of the options market, rather than that in the underlying stock. Surprisingly, volatility asymmetry is not relevant for RNS. Finally, the leverage ratio is not negatively but positively and strongly related with RNS. JEL classifications: C25; G10; G14