Optimal Portfolio Allocation with Option-Implied Moments: A Forward-Looking Approach

This paper proposes a forward-looking approach to estimate individual stock moments from option prices, including option-implied mean, volatility, beta, and covariance, and uses these inputs to determine optimal portfolios. We... [ view full abstract ]

This paper proposes a forward-looking approach to estimate individual stock moments from option prices, including option-implied mean, volatility, beta, and covariance, and uses these inputs to determine optimal portfolios. We find that using forward-looking information to form optimal portfolios leads to a significant improvement in out-of-sample performance. In particular, its superiority is largely due to the use of forward-looking mean. The superior performance of our forward-looking approach is significantly more pronounced during crisis periods, even after accounting for transactions costs.