Common Firm-level Investor Fears: Evidence from Equity Options

TL;DR

This paper introduces a new type of risk called common firm-level investor fears, derived from stock options, which influences stock returns and investor compensation, distinct from market fears.

Contribution

It identifies and measures common firm-level investor fears from options data, revealing their impact on stock returns and risk premiums, a novel approach compared to existing market fear analyses.

Findings

Stocks sensitive to bad fears have lower returns.

Risk premiums for bad fears range from -5.63% to -4.92% annually.

Investors demand higher compensation for exposure to bad fears.

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.