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Lottery and bubble stocks and the cross‐section of option‐implied tail risks

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  • Sobhesh Kumar Agarwalla
  • Sumit Saurav
  • Jayanth R. Varma

Abstract

The options smile provides forward‐looking information about the risk at the center of the distribution (ATM‐IV) and at the tails (Skew). We investigate the cross‐sectional determinants of the options smile using indices that capture firm fundamental risks, heterogeneity in belief, lottery characteristics, and bubble characteristics. We find that at‐the‐money (ATM) volatility is explained mainly by historical risks and predicted future risks measured using accounting‐based risk measures and firm characteristics. However, the cross‐sectional variation in the skew is driven by risk premia and by buying and selling pressure, which is influenced by heterogeneity in belief and the underlying's lottery‐like and bubble‐like characteristics.

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  • Sobhesh Kumar Agarwalla & Sumit Saurav & Jayanth R. Varma, 2022. "Lottery and bubble stocks and the cross‐section of option‐implied tail risks," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(2), pages 231-249, February.
    • Handle: RePEc:wly:jfutmk:v:42:y:2022:i:2:p:231-249
    DOI: 10.1002/fut.22263
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