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Implied volatility spreads, skewness and expected market returns

Atılgan, Yiğit and Bali, Turan G. and Demirtaş, K. Özgür (2010) Implied volatility spreads, skewness and expected market returns. (Submitted)

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Abstract

This paper investigates the intertemporal relation between implied volatility spreads and expected returns on the aggregate stock market. The results show a signi…cantly negative link between expected future returns and the spread between the implied volatilities of out-of-the-money put and at-the-money call options written on the S&P 500 index. We argue that this relation is driven by information flow from option markets to stock markets rather than volatility spreads acting as a proxy for skewness. First, neither physical nor risk-neutral skewness can predict expected aggregate returns. Second, the relation between volatility spreads and expected market returns is signi…cantly stronger for the periods that S&P 500 constituent …rms announce their earnings and for the periods that consumer sentiment index is extremely high or low. The intertemporal relation between volatility spreads and expected market returns remains strongly negative after controlling for various measures of conditional volatility, a large set of macroeconomic variables, small sample biases, and distributional assumptions.

Item Type:Article
Uncontrolled Keywords:implied volatility spreads, conditional skewness, expected market return, information ‡ow, intertemporal risk-return relation
Subjects:H Social Sciences > HG Finance
ID Code:16227
Deposited By:Yiğit Atılgan
Deposited On:22 Dec 2010 22:05
Last Modified:22 Dec 2010 22:05

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