The properties of a skewness index and its relation with volatility and returns

The objectives of this study are threefold. First, we investigate the properties of a skewness index in order to determine whether it captures fear (fear of losing money), or greed in the market (fear of losing opportunities). Second, we uncover the contemporaneous linear relationship among skewness, volatility and returns. Third, we provide evidence on the information content of skewness on future returns, which is highly debated in the literature. Fourth, we investigate the Italian market, where a skewness index is not traded yet. The methodology we propose for the construction of the Italian skewness index is applicable also to other European and non-European countries characterized by a limited number of option traded. Several results are obtained. First, in the Italian market the skewness index acts as measures of market greed, as opposed to market fear, namely that it measures more investors’ excitement than investors’ fear. Second, for almost 70% of the daily observations, the implied volatility and the skewness index move together but in opposite directions. Increases (decreases) in volatility and decreases (increases) in the skewness index are associated with negative (positive) returns. Last, we find strong evidence that positive returns are reflected both in a decrease in the implied volatility index and in an increase in the skewness index the following day. Implications for investors and policy makers are drawn.