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The Behavior of Volatility Expectations and Their Effects on Expected Returns

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  • Sheikh, Aamir M

Abstract

This article examines the behavior of common stock return volatility forecasts implied by call option prices and studies the relationship between implied volatilities and stock returns. The author estimates a model that integrates the findings of previous theoretical and empirical research. The author finds that implied. volatilities are significantly positively related to forecasts of market return volatility and to recent realizations of stock and market volatilities. The author's model is able to capture much of the previously unexplained cross-sectional and serial correlation in implied volatilities. Moreover, stock returns are found to be significantly positively related to lagged implied volatilities. Copyright 1993 by University of Chicago Press.

Suggested Citation

  • Sheikh, Aamir M, 1993. "The Behavior of Volatility Expectations and Their Effects on Expected Returns," The Journal of Business, University of Chicago Press, vol. 66(1), pages 93-116, January.
    • Handle: RePEc:ucp:jnlbus:v:66:y:1993:i:1:p:93-116
    DOI: 10.1086/296595
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    Cited by:

    1. David S. Bates, 1995. "Testing Option Pricing Models," NBER Working Papers 5129, National Bureau of Economic Research, Inc.
    2. Francesco Drudi & Roberto Violi, 1999. "Structure par terme des taux d'intérêt, volatilité et primes de risque : applications au marché de l'Eurolire," Économie et Prévision, Programme National Persée, vol. 140(4), pages 21-34.
    3. Sadayuki Ono, 2007. "Option Pricing under Stochastic Volatility and Trading Volume," Discussion Papers 07/05, Department of Economics, University of York.
    4. Ghysels, E. & Harvey, A. & Renault, E., 1995. "Stochastic Volatility," Papers 95.400, Toulouse - GREMAQ.
    5. Grunbichler, Andreas & Longstaff, Francis A., 1996. "Valuing futures and options on volatility," Journal of Banking & Finance, Elsevier, vol. 20(6), pages 985-1001, July.
    6. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    7. Lan Zhang, 2012. "Implied and realized volatility: empirical model selection," Annals of Finance, Springer, vol. 8(2), pages 259-275, May.
    8. Mixon, Scott, 2009. "Option markets and implied volatility: Past versus present," Journal of Financial Economics, Elsevier, vol. 94(2), pages 171-191, November.
    9. Lin, Jyh-Horng, 2000. "A contingent claim analysis of a rate-setting financial intermediary," International Review of Economics & Finance, Elsevier, vol. 9(4), pages 375-386, October.
    10. George O. Aragon & Rajnish Mehra & Sunil Wahal, 2018. "Do Properly Anticipated Prices Fluctuate Randomly? Evidence from VIX Futures Markets," NBER Working Papers 24575, National Bureau of Economic Research, Inc.

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