Volatility Spreads and Expected Stock Returns
AbstractThis paper investigates whether realized and implied volatilities of individual stocks can predict the cross-sectional variation in expected returns. Although the levels of volatilities from the physical and risk-neutral distributions cannot predict future returns, there is a significant relation between volatility spreads and expected stock returns. Portfolio level analyses and firm-level cross-sectional regressions indicate a negative and significant relation between expected returns and the realized-implied volatility spread that can be viewed as a proxy for volatility risk. The results also provide evidence for a significantly positive link between expected returns and the call-put options' implied volatility spread that can be considered as a proxy for jump risk. The parameter estimates from the VAR-bivariate-GARCH model indicate significant information flow from individual equity options to individual stocks, implying informed trading in options by investors with private information.
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Bibliographic InfoArticle provided by INFORMS in its journal Management Science.
Volume (Year): 55 (2009)
Issue (Month): 11 (November)
realized volatility; implied volatility; volatility risk; jump risk; stock returns;
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