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Volatility timing, sentiment, and the short-term profitability of VIX-based cross-sectional trading strategies

Wenjie Ding, Khelifa Mazouz and Qingwei Wang

Journal of Empirical Finance, 2021, vol. 63, issue C, 42-56

Abstract: This paper explores the profitability of simple short-term cross-sectional trading strategies based on the implied volatility index (VIX), often referred to as an “investor fear gauge” in the stock market. These strategies involve holding sentiment-prone stocks when VIX is low and sentiment-immune stocks when VIX is high and generate significantly higher excess returns than the benchmark long–short portfolios that do not condition on VIX. We show that the profitability of our trading strategies is not subsumed by the well-known risk factors or transaction cost adjustments. Our findings are consistent with the theory of delayed arbitrage and the synchronization problem of Abreu and Brunnermeier (2002).

Keywords: Implied volatility; Trading strategies; Cross-sectional return; Investor sentiment; Delayed arbitrage (search for similar items in EconPapers)
JEL-codes: G11 G12 G4 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:63:y:2021:i:c:p:42-56

DOI: 10.1016/j.jempfin.2021.05.003

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Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

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