Option-implied information and predictability of extreme returns

Grigory Vilkovz and Yan Xiaox

No 5, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: We study whether prices of traded options contain information about future extreme market events. Our option-implied conditional expectation of market loss due to tail events, or tail loss measure, predicts future market returns, magnitude, and probability of the market crashes, beyond and above other option-implied variables. Stock-specific tail loss measure predicts individual expected returns and magnitude of realized stock-specific crashes in the cross-section of stocks. An investor that cares about the left tail of her wealth distribution benefits from using the tail loss measure as an information variable to construct managed portfolios of a risk-free asset and market index.

Keywords: extreme value theory; tail measure; implied correlation; variance risk premium; option-implied distribution; predictability; portfolio optimization (search for similar items in EconPapers)
JEL-codes: G11 G12 G13 G17 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:5

DOI: 10.2139/ssrn.2209654

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