Model-Free Implied Dependence and the Cross-Section of Returns

We document the asset-pricing implications of the model-free option-implied dependence (MFID); a measure that exhibits information on linear and non-linear dependence between random variables. We show that stocks with high exposure to MFID generate significantly higher risk-adjusted returns in bad times. This is consistent with time-varying preferences, implying an increase in the demand for stocks that provide a hedge against an increase in dependence in bad times. The MFID premium cannot be explained by common risk factors – implying that a risk-based theory is not likely an explanation of the result – and is robust when we condition on implied correlation