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

This article examines the time-series predictive ability of the monthly option-implied idiosyncratic skewness (Skew) for the aggregate stock market. We find that Skew is a strong predictor of the U.S. equity premium using both in-sample and out-of-sample tests at forecast horizons up to 36 months over the period from January 1996 to December 2021. In addition, it delivers sizable economic gains for mean-variance investors in asset allocation. In comparison, Skew outperforms the previously used financial and macroeconomic variables. We also find that Skew is significantly related to future cash flows, investor attention, economic uncertainty, tail risks, and business conditions