What can you really tell from Option Prices?

Abstract

Option-implied risk-neutral moments are widely used throughout the asset pricing literature. In this paper, we characterize the information content of such option-implied moments, accounting for the market incompleteness inherent in empirical option markets. Our analysis relies on novel model-free bounds for a large class of risk-neutral moments built from a given option cross-section, which allow us to quantify the associated valuation uncertainty. We show that these bounds are infinite for almost all popular risk-neutral moments used in the literature, including the VIX, such that these moments cannot be reliably determined in practice. The lack of robustness in the specification of risk-neutral moments has effects that are profound both quantitatively and qualitatively, with ramifications for many well-known theories and empirical findings based upon them. As an alternative, we propose new robust moments and investigate their implications for the literature.

Joint with Oleg Bondarenko, Paul Schneider, and Fabio Trojani