Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options

This article provides several new insights into the economicsources of skewness. First, we document the differential pricingof individual equity options versus the market index and relateit to variations in return skewness. Second, we show how riskaversion introduces skewness in the risk-neutral density. Third,we derive laws that decompose individual return skewness intoa systematic component and an idiosyncratic component. Empiricalanalysis of OEX options and 30 stocks demonstrates that individualrisk-neutral distributions differ from that of the market indexby being far less negatively skewed. This article explains thepresence and evolution of risk-neutral skewness over time andin the cross section of individual stocks.