Volatility Spreads and Expected Stock Returns

Turan G. Bali () and Armen Hovakimian ()
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Turan G. Bali: Department of Economics and Finance, Zicklin School of Business, Baruch College, New York, New York 10010
Armen Hovakimian: Department of Economics and Finance, Zicklin School of Business, Baruch College, New York, New York 10010

Management Science, 2009, vol. 55, issue 11, 1797-1812

Abstract: This paper investigates whether realized and implied volatilities of individual stocks can predict the cross-sectional variation in expected returns. Although the levels of volatilities from the physical and risk-neutral distributions cannot predict future returns, there is a significant relation between volatility spreads and expected stock returns. Portfolio level analyses and firm-level cross-sectional regressions indicate a negative and significant relation between expected returns and the realized-implied volatility spread that can be viewed as a proxy for volatility risk. The results also provide evidence for a significantly positive link between expected returns and the call-put options' implied volatility spread that can be considered as a proxy for jump risk. The parameter estimates from the VAR-bivariate-GARCH model indicate significant information flow from individual equity options to individual stocks, implying informed trading in options by investors with private information.

Keywords: realized volatility; implied volatility; volatility risk; jump risk; stock returns (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (126)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:55:y:2009:i:11:p:1797-1812

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