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Session Overview
APE-12: Asset Price Predictability II
Friday, 25/Aug/2017:
10:30am - 12:00pm

Session Chair: Loriana Pelizzon, Goethe University Frankfurt
Location: SN163

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Margin Requirements and Equity Option Returns

Steffen Hitzemann1, Michael Hofmann2, Marliese Uhrig-Homburg2, Christian Wagner3

1The Ohio State University; 2Karlsruhe Institute of Technology; 3Copenhagen Business School

Discussant(s): Mario Bellia (Goethe University Frankfurt, SAFE)

In equity option markets, traders face margin requirements both for the options themselves and for hedging-related positions in the underlying stock market. We show that these requirements carry a significant "margin premium" in the cross-section of equity option returns. The sign of the margin premium depends on demand pressure: If end-users are on the long side of the market, option returns decrease with margins, while they increase otherwise. Our results are statistically and economically significant and robust to different margin specifications and various control variables. We explain our findings by a model of funding-constrained derivatives dealers that require compensation for satisfying end-users’ option demand.

EFA2017-398-APE-12-Hitzemann-Margin Requirements and Equity Option Returns.pdf

Equity Premium Predictability from Cross-Sectorial Downturns

Jose Faias1, Juan Zambrano2

1Católica Lisbon School of Business and Economics; 2University of Reading

Discussant(s): Grigory Vilkov (Frankfurt School of Finance and Management)

We develop a sectorial consumption asset-pricing model that endogenously incorporates shocks imperceptible at the aggregate level. This model illustrates that left tail dependence impacts the equity risk premium. We proxy left tail dependence by the average of pairwise left tail dependency among major sectors, and we demonstrate that it significantly predicts the equity risk premium in- and out-of-sample. Using this measure as a predictor in an asset allocation exercise yields a strategy with positive skewness and an out-of-sample Sharpe ratio of 0.56 from 1998 to 2013, which is at least twofold higher than that for all other univariate specifications.

EFA2017-850-APE-12-Faias-Equity Premium Predictability from Cross-Sectorial Downturns.pdf

Gold, Platinum, and Expected Stock Returns

Darien Huang

Cornell University

Discussant(s): Paola Pederzoli (University of Geneva)

The ratio of gold to platinum prices (GP) reveals persistent variation in risk and proxies for an important economic state variable. GP predicts future stock returns in the time-series, explains stock return variation in the cross-section, and is significantly correlated with option-implied tail risk measures. Contrary to conventional wisdom, gold prices fall in recessions, albeit by less than platinum prices. A model featuring recursive preferences, time-varying tail risk, and preference shocks for gold and platinum can account for asset pricing dynamics of equity, gold, and platinum, rationalize the return predictability, and explain why gold prices fall in bad times.

EFA2017-1875-APE-12-Huang-Gold, Platinum, and Expected Stock Returns.pdf

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