The Options-Inferred Equity Premium and the Slippery Slope of the Negative Correlation Condition
Vol. 22, No. 3, 2024
Gurdip Bakshi, John Crosby, Xiaohui Gao, Jinming Xue and Wei Zhou
The negative correlation condition (NCC) of Martin (2017) is that covPt (MT RT,RT )≤ 0 for all MT, where MT is the SDF and RT 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 MT contradict the universality of the NCC, exhibit variance-dependence and incorporate an increasing region to the return upside.