Critical Finance Review > Vol 11 > Issue 2

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

Paul Borochin, Miami Herbert Business School, University of Miami, USA, paul.borochin@bus.miami.edu , Yanhui Zhao, College of Business and Economics, University of Wisconsin-Whitewater, USA, zhaoya@uww.edu
 
Suggested Citation
Paul Borochin and Yanhui Zhao (2022), "Risk Neutral Skewness Predicts Price Rebounds and So Can Improve Momentum Performance", Critical Finance Review: Vol. 11: No. 2, pp 383-429. http://dx.doi.org/10.1561/104.00000101

Publication Date: 03 May 2022
© 2022 Paul Borochin and Yanhui Zhao
 
Subjects
 
Keywords
G12G13
Risk neutral skewnessMomentumReturn predictability
 

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In this article:
1. Introduction 
2. Data and Variable Construction 
3. The Risk Neutral Skewness Anomaly and Momentum 
4. The Risk Neutral Skewness Factor-Mimicking Portfolio 
5. Conclusion 
Appendices 
References 

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.

DOI:10.1561/104.00000101