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VIX Index and Stock Returns Following Large Price Moves

Andrey Kudryavtsev

Journal of Risk & Control, 2017, vol. 4, issue 1, 71-101

Abstract: My study explores the effect of future volatility expectations, embedded in VIX index, on large daily stock price changes and on subsequent stock returns. Following both psychological and financial literature claiming that good (bad) mood may cause people to perceive positive (negative) future outcomes as more probable and that the changes in the value of VIX may be negatively correlated with contemporaneous investors’ mood, I hypothesize that if a major positive (negative) stock price move takes place on a day when the value of VIX falls (rises), then its magnitude may be amplified by positive (negative) investors' mood, creating price overreaction to the initial company-specific shock, which may result in subsequent price reversal. In line with my hypothesis, I document that both positive and negative large price moves accompanied by the opposite-sign contemporaneous changes in VIX are followed by significant reversals on the next two trading days and over five- and twenty-day intervals following the event, the magnitude of the reversals increasing over longer post-event windows, while large stock price changes taking place on the days when the value of VIX moves in the same direction are followed by non-significant price drifts. The results remain robust after accounting for additional company (size, beta, historical volatility) and event-specific (stock's return and trading volume on the event day) factors, and are stronger for small and volatile stocks.

Keywords: Behavioral Finance; Large Price Changes; Mood; Overreaction; Stock Price Reversals; Volatility Expectations; VIX. (search for similar items in EconPapers)
JEL-codes: G11 G14 G19 (search for similar items in EconPapers)
Date: 2017
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