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A Bound on Expected Stock Returns

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We present a sufficient condition under which the prices of options with different strike prices written on a particular stock can be used to calculate a lower bound on the expected returns of that stock. The sufficient condition imposes a restriction on a combination of the stock’s systematic and idiosyncratic risk. The lower bound is forward-looking and can be calculated on a high-frequency basis for stocks with liquid option trading. We estimate the lower bound empirically for constituents of the S&P 500 index and study its cross-sectional properties. We find that the bound increases with beta and decreases with size. The bound also provides an economically meaningful signal on future realized stock returns.

This talk is part of the Finance & Accounting Seminar Series series.

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