Abstract: We find consistent evidence across ratings and regions that delta-hedged credit index options have large negative Sharpe ratios and much more so than their equity index counterparts. Risk-factors extracted from equity index options have only moderate explanatory power for the time-series and cross-sectional variation in credit option returns, while a single credit-specific factor explains much of the remaining variation. We link this factor to credit option order flow in a manner that is consistent with the predictions of a demand-based option pricing model, in which order-flow risk is priced in equilibrium.
Mahyar Kargar, University of Illinois-Urbana-Champaign
Jiacui Li, University of Utah
Abstract: Classical asset pricing models predict that optimizing investors exhibit extremely high demand elasticities, while empirical estimates are significantly lower—by three orders of magnitude. To reconcile this disparity, we introduce a novel decomposition of investor demand elasticity into two key components: “price pass-through,” which captures how price movements forecast returns, and “unspanned returns,” reflecting a stock’s lack of perfect substitutes. In a factor model framework, we show that unspanned returns become significant when models include “weak factors.” Classical models overestimate demand elasticity by assuming both very low unspanned returns and high price pass-throughs, assumptions that are inconsistent with empirical evidence.
Discussant: Paul Huebner, Stockholm School of Economics
Abstract: We develop a framework to extract heterogeneous investors’ subjective beliefs by combining option prices and portfolio holdings. We show how to recover investor-specific expectations of returns and risk, consensus beliefs, and belief dispersion. Applying it to S\&P 500 options’ buy–sell order data, we find that subjective expected returns and Sharpe ratios vary by investor type and depend on portfolio composition. Beliefs inferred from prices alone display strong counter-cyclicality, whereas those incorporating holdings can reverse sign, exhibit muted cyclicality, and align with professional survey expectations under market-timing strategies. Our results highlight the value of holdings data in belief recovery.
