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Implied volatility spreads and expected market returns

Atılgan, Yiğit and Bali, Turan G. and Demirtaş, Özgür (2015) Implied volatility spreads and expected market returns. Journal of Business and Economic Statistics, 33 (1). pp. 87-101. ISSN 0735-0015 (Print) 1537-2707 (Online)

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Official URL: http://dx.doi.org/10.1080/07350015.2014.923776

Abstract

This article investigates the intertemporal relation between volatility spreads and expected returns on the aggregate stock market. We provide evidence for a significantly negative link between volatility spreads and expected returns at the daily and weekly frequencies. We argue that this link is driven by the information flow from option markets to stock markets. The documented relation is significantly stronger for the periods during which (i) S&P 500 constituent firms announce their earnings; (ii) cash flow and discount rate news are large in magnitude; and (iii) consumer sentiment index takes extreme values. The intertemporal relation remains strongly negative after controlling for conditional volatility, variance risk premium, and macroeconomic variables. Moreover, a trading strategy based on the intertemporal relation with volatility spreads has higher portfolio returns compared to a passive strategy of investing in the S&P 500 index, after transaction costs are taken into account.

Item Type:Article
Uncontrolled Keywords:expected market returns, volatility spreads, option markets, information flow
Subjects:H Social Sciences > HG Finance > HG4501-6051 Investment, capital formation, speculation
ID Code:27774
Deposited By:Yiğit Atılgan
Deposited On:16 Dec 2015 15:03
Last Modified:16 Dec 2015 15:03

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