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RFS Advance Access published online on February 22, 2006
Review of Financial Studies, doi:10.1093/rfs/hhj030
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Article

Option Coskewness and Capital Asset Pricing

Joel M.Vanden 1 *
1 Tuck School of Business, Dartmouth College, Hanover, NH

* To whom correspondence should be addressed.
Joel M.Vanden, E-mail: joel.m.vanden{at}dartmouth.edu


  Abstract

This article shows how the market coskewness model of Rubinstein (1973) and Kraus and Litzenberger (1976) is altered when a nonredundant call option is optimally traded. Due to the option’s nonredundancy, the economy’s stochastic discount factor depends not only on the market return and the square of the market return, but also on the option return, the square of the option return, and the product of the market and option returns. This leads to an asset pricing model in which the expected return on any risky asset depends explicitly on the asset’s coskewness with option returns. The empirical results show that the option coskewness model outperforms several competing benchmark models. Furthermore, option coskewness captures some of the same risks as the Fama-French factors SMB and HML. These results suggest that the factors that drive the pricing of nonredundant options are also important for pricing risky equities.

Keywords: asset pricing, coskewness, cokurtosis, options trading.
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