Working Papers
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Text-Based Risk Similarity and Economic Links, with Runfeng Yang
Abstract: This paper introduces a text-based risk similarity measure using firms' risk disclosures, and documents a cross-stock momentum effect among firms with high similarity ("risk peers"). This measure cannot be subsumed by the well-documented cross-stock momentum patterns, and uncovers linkages not captured by existing economic link measures. The effects are stronger when: (1) focal firms receive less attention or have higher limits to arbitrage; (2) risk peers are not in the same industry; (3) there are changes in risk disclosure. The predictability also extends to higher-order moments of returns. Overall, similarity in risk disclosures offers a broad and informative lens for identifying firm-level economic links and their implications for cross-stock return predictability.
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OPIN and the Cross Section of Equity Option Returns, with Guanglian Hu and Runfeng Yang
Abstract: We construct a novel probability of informed trading measure for equity options, or OPIN, using signed trading quantities. We find that options with higher OPIN are associated with significantly lower future delta-hedged returns, suggesting that options market makers demand a larger risk premium when facing heightened informed trading risk. This relationship holds across option contract types, is robust to alternative empirical implementations, and amplified when hedging costs are higher or the underlying firm information asymmetry is more severe. Overall, our findings suggest that informed trading risk is priced, and that exploiting private information in the options market is not costless.
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Option-Implied Market Risk Premium and the CAPM, with Xiaoyu Kang and Quan Gan
Abstract: We show that the positive beta-return relation predicted by the CAPM emerges strongly in periods when the option-implied market risk premium is high. Unlike the ex-post market risk premium, which is noisy and often negative, the option-implied premium is derived from a model-free lower bound on the equity premium and is always positive, providing a forward-looking measure of investors' required compensation for market risk. Conditioning on this measure reveals a robust beta-return trade-off, consistent with periods of elevated aggregate risk aversion restoring the validity of the CAPM. These results are not driven by macroeconomic or earnings announcements, nor by variation in sentiment, disagreement, investor attention, inflation, variance risk premium, or VIX. Our findings highlight the importance of using forward-looking risk-premium measures to uncover conditional asset-pricing relationships that remain hidden in unconditional tests.
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Testing the CAPM in Equity Options: Earnings Announcements as Catalysts for Market Efficiency, with Quan Gan, Alex Horenstein, and Aurelio Vasquez
Abstract: We test the performance of the capital asset pricing model (CAPM) in pricing equity options. We find a strong and positive relation between option beta and option returns during earnings announcement days (EADs), which becomes insignificant on non-announcement days. This option return premium around EADs can be fully explained by option beta. The beta-sorted return spread exhibits strong pre-announcement drift and does not reverse after the announcement. We show that increased investor attention and end-user option demand demands amplify systematic risk pricing. Unlike equities, option returns are driven by systematic risk, not idiosyncratic volatility or mispricing. CAPM’s effectiveness depends on public information and investor engagement.
Selected Publications