We document evidence that average future stock returns are monotonically increasing in the slope of option implied volatility smile. The trading strategies that long high slope stocks and short low slope stocks generate significant positive returns, which cannot be explained by stock characteristics like beta, past return, volatility, size, book-to-market, leverage, and trading volume; or by
... [Show full abstract] existing risk factors like Market, SMB, HML, and MOM. Our findings are consistent with a rational asset pricing model in which the slope of option implied volatility smile is negatively proportional to the arrival intensity and average size of systematic jumps in the underlying stock price process. We propose the "slope" factor to proxy jump risk and find it to explain cross-sectional stock returns.
