In the first chapter, my coauthor and I examine the information content of option and equity volumes when trade direction is unobserved. In a multimarket asymmetric information model, equity short-sale costs result in a negative relation between relative option volume and future firm value. In our empirical tests, firms in the lowest decile of the option to stock volume ratio (O/S) outperform the highest decile by 0.34% per week (19.3% annualized). Our model and empirics both indicate that O/S is a stronger signal when short-sale costs are high or option leverage is low. O/S also predicts future firm-specific earnings news, consistent with O/S reflecting private information. In the second chapter, I show that in many asset pricing models, the equity market's expected return is a time-invariant linear function of its conditional variance, which can be estimated from options markets. However, I show that when the relation between conditional means and variances is state-dependent, an observer requires the combined information in multiple variance horizons to distinguish among the states and thereby reveal the equity risk premium. Empirically, I show that while the VIX by itself has little predictive power for future S & P 500 returns, the VIX term structure predicts next-quarter S & P 500 returns with a 5.2% adjusted R-squared.

This dissertation, "Two Essays on Asset Pricing and Options Market" by Huimin, Zhao, 趙慧敏, was obtained from The University of Hong Kong (Pokfulam, Hong Kong) and is being sold pursuant to Creative Commons: Attribution 3.0 Hong Kong License. The content of this dissertation has not been altered in any way. We have altered the formatting in order to facilitate the ease of printing and reading of the dissertation. All rights not granted by the above license are retained by the author. DOI: 10.5353/th_b4150839 Subjects: Options (Finance) Capital assets pricing model

"This thesis consists of three essays that explore alternative approaches to extracting information from option data, and, along somewhat different lines, examine the channels through which liquidity is priced in equity options.The first essay proposes a novel approach to extracting option-implied equity premia, and empirically examines the information content of these risk premia for forecasting the stock market return. Our approach does not require specifying the functional form of the pricing kernel, and does not impose any restrictions on investors' preferences. We only assume the existence of put and call options which complete the market, and show that the implied equity premium can be inferred from expected excess returns on a portfolio of options. An empirical investigation of S&P 500 index options yields the following conclusions: (i) the implied equity premium predicts stock market returns; (ii) the implied equity premium consistently outperforms variables commonly used in the forecasting literature both in- and out-of-sample; (iii) the implied equity premium is positively related to future returns and negatively related to current returns, as theoretically expected.The second essay studies the effect of illiquidity on equity option returns. Illiquidity is well-known to be a significant determinant of stock and bond returns. We are the first to report on illiquidity premia in equity option markets using a large cross-section of firms. An increase in option illiquidity decreases the current option price and predicts higher expected delta-hedged option returns. This effect is statistically and economically significant, and it is consistent with existing evidence that market makers in the equity options market hold net long positions. The illiquidity premium is robust across puts and calls, across maturities and moneyness, as well as across different empirical approaches. It is also robust when controlling for various firm-specific variables including a standard measure of illiquidity of the underlying stock. For long term options, we find evidence of a liquidity risk factor. In the third essay, we demonstrate that in multifactor asset pricing models, prices of risk for factors that are nonlinear functions of the market return can be readily obtained using data on index returns and index options. We apply this general result to the measurement of the conditional price of coskewness and cokurtosis risk. The price of coskewness risk corresponds to the spread between the physical and the risk-neutral second moments, and the price of cokurtosis risk corresponds to the spread between the physical and the risk-neutral third moments. Estimates of these prices of risk have the expected sign, and they lead to reasonable risk premia. An out-of-sample analysis of factor models with coskewness and cokurtosis risk indicates that the new estimates of the price of risk improve the models. performance. The models also robustly outperform competitors such as the CAPM and the Fama-French model." --