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Option-Implied Volatility Measures and Stock Return Predictability

Fu, Xi; Arisoy, Y. Eser; Shackleton, Mark B.; Umutlu, Mehmet

Authors

Xi Fu

Y. Eser Arisoy

Mark B. Shackleton



Abstract

Do changes in implied volatilities (IVs) or differences among options at different spots on the volatility surface contain predictive information for future returns? The question has been asked repeatedly—and often answered in the affirmative for specific measures—but questions remain. In this article, the authors perform a comparison test on six return predictors that are all computed as differences among implied and realized volatilities and that have been proposed in the literature. The authors consider more measures, more maturities, and longer samples than earlier articles, and they include a variety of appropriate control variables. They find that the difference between at-the-money (ATM) call and put IV (CPIV) and out-of-the-money (OTM) put IV minus ATM call IV are both highly significant at the individual stock level, while a long–short portfolio strategy based on realized minus implied volatility does very well. The alternative volatility combinations are substantially less effective as return predictors.

Journal Article Type Article
Online Publication Date Aug 31, 2016
Publication Date 2016-08
Deposit Date Jan 29, 2023
Journal The Journal of Derivatives
Print ISSN 1074-1240
Electronic ISSN 2168-8524
Peer Reviewed Peer Reviewed
Volume 24
Issue 1
Pages 58-78
DOI https://doi.org/10.3905/jod.2016.24.1.058
Keywords Options, quantitative methods, analysis of individual factors/risk premia