The Options-Inferred Equity Premium and the Slippery Slope of The Negative Correlation Condition

Authors

Gurdip Bakshi, Temple University-Fox School of BusinessFollow
John Crosby, University of Maryland - Robert H. Smith School of BusinessFollow
Xiaohui Gao, Temple University-Fox School of BusinessFollow
Jinming Xue, Southern Methodist University (SMU) - Finance DepartmentFollow

Publication Date

7-6-2017

Abstract

The negative correlation condition (NCC) of Martin (2017) is that cov P t (M T R T , R T) ≤ 0 for all M T , where M T is the SDF and R T is the gross market return. He employs this assumption to derive a lower bound of the equity premium. This paper exploits theoretical and empirical constructions to refute the hypothesis of the NCC. Using options on the S&P 500 index and STOXX 50 equity index, our tests favor rejection. Our empirical counterexamples of M T contradict the universality of the NCC, exhibit variance-dependence and incorporate an increasing region to the return upside.

Document Type

Article

Keywords

Hypothesis and generality of the negative correlation condition, dark matter property, conditional equity premium, options on S&P 500 equity index and STOXX 50 equity index

Disciplines

Finance

DOI

10.2139/ssrn.5048945

Source

SMU Cox: Finance (Topic)

Language

English