Improving Portfolio Selection Using Option-Implied Volatility and Skewness

Raman Uppal, Victor DeMiguel, Yuliya Plyakha () and Grigory Vilkov

No 7686, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Our objective in this paper is to examine whether one can use option-implied information to improve mean-variance portfolio selection with a large number of stocks, and to document which aspects of option-implied information are most useful for improving the out-of-sample performance of mean-variance portfolios. To calculate the optimal mean-variance portfolio weights, one needs to estimate for each stock its volatility, correlations with all other stocks, and expected return. Our empirical evidence shows that, while using the option-implied volatilities and correlations does not improve significantly the portfolio variance, Sharpe ratio, and certainty-equivalent return, exploiting information about expected returns that is contained in the volatility risk premium and option-implied skewness increases substantially Sharpe ratios and certainty-equivalent returns, but this is accompanied by higher portfolio turnover.

Keywords: Mean-variance; Option-implied skewness; Option-implied volatility; Portfolio optimization; Variance risk premium (search for similar items in EconPapers)
JEL-codes: G11 G12 G13 G17 (search for similar items in EconPapers)
Date: 2010-02
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

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Journal Article: Improving Portfolio Selection Using Option-Implied Volatility and Skewness (2013)
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