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Implied volatility indices as leading indicators of stock index returns ?

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  • GIOT, Pierre

Abstract

This paper shows that, when the VIX or VXN indices of implied volatility increase, the S&P100 and NASDAQ100 stock indices exhibit on average negative returns, hence the 'fear factor' associated with high levels of implied volatility in financial markets. However, attractive (from a mean-variance perspective) positive returns should then be expected on average in the immediate short-term. In this framework, very high levels of implied volatility can on a statistical basis be viewed as signalling an imminent increase in stock indices, at least on a short term basis. Our analysis also shows that average to moderately high levels of implied volatility lead to unfavorable (from a mean-variance perspective) returns. Thus traders willing to enter 'oversold' markets should wait until extremely high levels of implied volatility are witnessed, and their strategy should be strictly on a short-term basis.

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  • GIOT, Pierre, 2002. "Implied volatility indices as leading indicators of stock index returns ?," LIDAM Discussion Papers CORE 2002050, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    • Handle: RePEc:cor:louvco:2002050
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    File URL: https://sites.uclouvain.be/core/publications/coredp/coredp2002.html
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    Cited by:

    1. Guido Russi, 2012. "Estimating the Leverage Effect Using High Frequency Data," Review of Economics & Finance, Better Advances Press, Canada, vol. 2, pages 1-24, February.
    2. Bart Frijns & Alireza Tourani-Rad & Yajie Zhang, 2008. "The New Zealand implied volatility index," New Zealand Economic Papers, Taylor & Francis Journals, vol. 42(1), pages 103-125.
    3. Söylemez, Arif Orçun, 2020. "How Do Volatility and Return Series Interact?," MPRA Paper 104687, University Library of Munich, Germany.
    4. Long, Wen & Zhao, Manyi & Tang, Yeran, 2021. "Can the Chinese volatility index reflect investor sentiment?," International Review of Financial Analysis, Elsevier, vol. 73(C).

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