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Forecasting returns and risk through implied volatility: A dual-threshold investment framework

Author

Listed:
  • Chih-hsiang Hsu

    (Department of Finance, Ming Chuan University, Taiwan)

Abstract

This study explores the non-linear relationship between implied volatility and future equity returns. We document a U-shaped link between implied volatility and ETF performance across three index pairs: VIX-SPY, VXN-QQQ, and VXD-DIA, suggesting that extreme volatility may signal market rebounds. Based on this, we develop a two-threshold trading rule that reallocates between equities and bonds. Backtesting results show that the strategy improves risk-adjusted returns and reduces drawdowns relative to a buy-and-hold approach.

Suggested Citation

  • Chih-hsiang Hsu, 2025. "Forecasting returns and risk through implied volatility: A dual-threshold investment framework," Economics Bulletin, AccessEcon, vol. 45(4), pages 1926-1938.
    • Handle: RePEc:ebl:ecbull:eb-25-00196
    as

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    References listed on IDEAS

    as
    1. Campbell, John Y. & Hentschel, Ludger, 1992. "No news is good news *1: An asymmetric model of changing volatility in stock returns," Journal of Financial Economics, Elsevier, vol. 31(3), pages 281-318, June.
    2. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(3), pages 823-866.
    3. Bali, Turan G. & Demirtas, K. Ozgur & Levy, Haim, 2009. "Is There an Intertemporal Relation between Downside Risk and Expected Returns?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(4), pages 883-909, August.
    4. Lee, Jason & Yi, Cheong H., 2001. "Trade Size and Information-Motivated Trading in the Options and Stock Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(4), pages 485-501, December.
    Full references (including those not matched with items on IDEAS)

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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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