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Risk Neutral Skewness Predicts Price Rebounds and So Can Improve Momentum Performance

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  • Paul Borochin
  • Yanhui Zhao

Abstract

Positive option-implied risk-neutral skewness (RNS) predicts next-month abnormal underlying stock returns driven by upward rebounds of previously undervalued stocks. The RNS anomaly is strongest in periods of post-recession rebounds when momentum crashes occur. Furthermore, the momentum anomaly is strongest (weakest) in stocks with the most negative (positive) RNS. We generalize our findings to non-optionable stocks by constructing an RNS factor-mimicking portfolio, finding that a momentum strategy that avoids performance reversals has meaningfully superior performance. Our results hold after controlling for trading frictions, firm characteristics, and common risk factors.

Suggested Citation

  • Paul Borochin & Yanhui Zhao, 2022. "Risk Neutral Skewness Predicts Price Rebounds and So Can Improve Momentum Performance," Critical Finance Review, now publishers, vol. 11(2), pages 383-429, May.
    • Handle: RePEc:now:jnlcfr:104.00000101
    DOI: 10.1561/104.00000101
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    More about this item

    Keywords

    Risk neutral skewness; Momentum; Return predictability;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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