In this article, we use volatility surface data from options contracts to document a strong, robust, and positive cross-sectional relation between risk-neutral skewness (RNS) and subsequent stock returns. The differential return between high- and low-RNS stocks amounts to 0.17% per week. Preannouncement RNS is positively related to earnings announcement returns, and the positive RNS–return relation is more pronounced for other nonscheduled news releases. This suggests that it is informed trading that drives the positive relation between RNS and subsequent stock returns. We also find that RNS contains incremental information beyond trading signals captured by option-implied volatility and volume.

The literature offers various explanations to either support or refute the Ang et al. () high idiosyncratic volatility low return puzzle. Fu () finds a significantly positive contemporaneous relation between return and exponential generalized autoregressive conditional heteroskedastic idiosyncratic volatility. We use corporate hedging to shed light on this puzzle. Conceptually, idiosyncratic volatility matters to investors who face limits to diversification. But limits to diversification become less relevant for firms that consistently hedge. We confirm the main finding in Fu (), but only for firms that do not consistently hedge. For firms that adopt a consistent hedging policy, idiosyncratic volatility, whether contemporaneous or lagged, is insignificant in Fama–MacBeth regressions, controlling for size, book‐to‐market, momentum, liquidity, and industry effects.

We examine credit risk price discovery between the U.S. equity and credit default swap (CDS) markets for 174 firms between 2005 and 2009. ] measures, we uncover an interesting price discovery transmigration pattern. Before the global financial crisis (GFC), CDS influences price discovery for 92 firms. During the height of the GFC, it increases to 159 firms, despite rising and increasingly volatile CDS spreads. Although the number of firms decrease post-GFC, it remains high compared to the pre-GFC period. The substantially higher and more volatile CDS spreads present informed speculators attractive trading opportunities in the CDS market that were not available before the GFC.In contrast, the GFC is a credit crisis, and credit risk can be hedged with CDS contracts. Like all derivative markets, the CDS market facilitates risk-sharing. Keynes (1923) argues that risk averse hedgers will pay a premium to take positions against more informed speculators. Figure 1 shows that, prior to mid-2007, CDS spreads were low and tranquil. Trading in the CDS market is conducted mainly by commercial banks, pension funds and insurance firms through their uncorrelated hedging demand associated with idiosyncratic lending and investing activities. With the onset of the GFC, credit risk became a prime concern. Hedgers increased their demand for risk-sharing and were willing to pay a higher premium for protection against default. And it is the higher and more volatile spreads during the GFC that makes the CDS market attractive to informed speculators.Keynes's argument is also consistent with why index futures markets did not attract liquidity from informed speculators during the 1987 crash. Since liquidity risk was the main concern, it was not clear to informed speculators that the demand for hedging market risk would increase. Conversely, the main concern during the GFC was credit risk, and Keynes (1923) implies that a surge in demand and premium offered by hedgers for credit risk-sharing during the GFC will attract more informed speculators into the CDS market.

No abstract

No abstract