Option-Implied Idiosyncratic Skewness and Expected Returns : Mind the Long Run

This article examines the time-series predictive ability of monthly option-implied idiosyncratic skewness (Skew, hereafter) for stock market excess returns. Skew is a strong negative predictor of returns with particular strong power at long horizons. Specifically, the out-of-sample R^2 statistics of Skew are 43.26% and 33.35% at 24 and 36 months, respectively, dominantly outperforming the sample average benchmark and other previously studied predictors. Also, Skew generates significant economic gains for a mean-variance investor. The ability of Skew to predict future returns is partly due to its relations with cash flows, investor sentiment, market attention, economic uncertainty, tail risks, and business conditions