Information Flow between Stock Skew and Options Risk Neutral Skew: Evidence from KOSPI200 Options

Abstract

This paper investigates the effects of risk neutral distribution (RND) from option prices on the distribution of the underlying asset. More specifically, we focus on the third moment of distribution, called skewness, which contains important information predicting the jumps of stock index. The sample period covers from January 2002 to July 2006 with the closing price returns of KOSPI200 Index and the KOSPI200 options. The skewness of the risk neutral distribution is estimated from non-parametric method of Bakshi et al.(2003) and the parametric method of Corrado and Su (1996). When estimating the skewness of the underlying assets, we employ Chen et al.(2001) model and calculate the historical skewness from the1-month ahead return underlying asset. Using statistical methodology such as VAR (Vector Autoregressive model), Granger causality test, impulse response and variance decomposition model, we examine whether the skewness of the underlying asset responds to the change of the implied RND. Followings are the major findings and implications drawn from the empirical analysis of the Korean options market. First of all, skewness of options estimated from non-parametric method have information contents predicting the third-moment of KOSPI200 index return whereas skewness of options estimated from parametric method does not have any information forecasting the skewness of KOSPI200 index return.

Citation

Kim, S., Park, H.-H. and Eom, K.-J. (2013), "Information Flow between Stock Skew and Options Risk Neutral Skew: Evidence from KOSPI200 Options", Journal of Derivatives and Quantitative Studies: 선물연구, Vol. 21 No. 1, pp. 97-133. https://doi.org/10.1108/JDQS-01-2013-B0004