Expected Stock Returns and Option-Implied Rate of Return : WestminsterResearch

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Title	Expected Stock Returns and Option-Implied Rate of Return
Type	Journal article
Authors	Ze-To, S.
Abstract	This paper examines the predictability of implied required rate of return (ROI) of individual stock in the cross-section of stock returns. The required rate of return of each stock is implied using its corresponding stock options and used in es-timating the fundamental value of stock. The study finds that stocks with low price to fundamental value have higher future returns. The inferred ROI is compared with other required rate of return derived by CAPM and Fama-French three factor model in return prediction and trading. The findings indicate that the proposed model outperforms the other two models. The forward looking ROI provides a superior estimation of fundamental value than the other two back-looking models and is better able to predict future returns. The empirical results also evidence that the proposed model provides accurate trading signals compared with the other valuation models as well as value benchmarks like price to earnings and dividend yield ratios.
Keywords	Implied Rate of Return; Options
Journal	Journal of Mathematical Finance
Journal citation	2 (4), pp. 269-279
ISSN	2162-2434
	2162-2442
Year	2012
Publisher	Scientific Research
Digital Object Identifier (DOI)	https://doi.org/10.4236/jmf.2012.24030
Published	Nov 2012

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Expected Stock Returns and Option-Implied Rate of Return

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