Common Firm-level Investor Fears: Evidence from Equity Options

Paper: arXiv 2309.03968

Authors: Jozef Barunik, Mattia Bevilacqua, Michael Ellington

Abstract

We identify a new type of risk, common firm-level investor fears, from commonalities within the cross-sectional distribution of individual stock options. We define firm-level fears that link with upward price movements as good fears, and those relating to downward price movements as bad fears. Such information is different to market fears that we extract from index options. Stocks with high sensitivities to common firm-level investor fears earn lower returns, with investors demanding a higher compensation for exposure to common bad fears relative to common good fears. Risk premium estimates for common bad fears range from -5.63% to -4.92% per annum.

Complexity vs Empirical Score

• Math Complexity: 6.5/10
• Empirical Rigor: 6.0/10 (capped from 8.0: transaction costs not modelled; see penalty flags)
• Quadrant: Holy Grail — high math complexity, high empirical rigor

Why this score: The paper introduces a novel separation of firm-level implied volatility tail risk (‘good’ vs. ‘bad’ fears) from index-level market risk using option surface cross-sections. It features robust cross-sectional asset pricing methodology, detailed portfolio sorts, and rigorous Fama-MacBeth regressions demonstrating a statistically significant risk premium.

Research Flowchart

  flowchart TD
    A[Identify & Price Common Firm-Level Investor Fears] --> B[Data: Individual Stock Options & Index Options]
    B --> C[Extract Cross-Sectional Option Commonalities]
    C --> D[Separate into Good Fears Upward & Bad Fears Downward]
    D --> E[Asset Pricing Model: Measure Stock Sensitivities & Betas]
    E --> F[Findings: High Sensitivity Stocks Earn Lower Returns]
    F --> G[Outcome: Bad Fear Risk Premium = -4.92% to -5.63% p.a.]