Informational content of options around analyst recommendations

Qingxia Wang, Robert Faff and Min Zhu

International Journal of Managerial Finance, 2021, vol. 18, issue 3, 445-465

Abstract: Purpose - More studies have investigated the relation between option measures and stock returns during scheduled corporate events. This study adds to the literature and investigates the informational role of options concerning stock returns following unscheduled corporate news events. The authors focus on individual analysts' recommendation changes rather than consensus revisions, as the recommendation consensus might discard a large amount of potentially valuable information in the aggregation process. Design/methodology/approach - Based on the econometric model, the authors follow Bakshiet al.(2003) to construct the model-free option implied measures. The authors further decompose the implied option variance into upside and downside components. In such a way, the different informational roles of call and put options can be distinguished. A variety of regression analyses are conducted to examine the predictive power of option implied measures, and the ordered probit model is used to test the tipping hypothesis of analyst recommendations. Findings - This study’s results show that the option market impounds the “valuable” firm-specific news; thus, the pre-event option market is strongly related to stock returns around recommendations even though recommendation changes are largely “unscheduled”. At the same time, these results suggest that upside (good) and downside (bad) implied volatilities contain distinctive information on subsequent stock returns. Originality/value - This study provides new evidence that an increase in upside (downside) volatility around analyst recommendation changes would increase the probability that analysts upgrade (downgrade) the stock. The findings provide implications for investors and risk managers in making investment decisions.

Keywords: Good (bad) implied variance; Informed traders; Analyst recommendations; Analyst tipping; G12; G14; G24 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eme:ijmfpp:ijmf-04-2021-0168

DOI: 10.1108/IJMF-04-2021-0168

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