Predicting Extreme Returns and Portfolio Management Implications
University of West Florida
University of Tulsa
University of Missouri - Kansas City
May 14, 2012
We consider which readily observable characteristics of individual stocks (e.g., option implied volatility, accounting data, analyst data) may be used to forecast subsequent extreme price movements. We are the first to explicitly consider the predictive influence of option implied volatility in such a framework, which we unsurprisingly find to be an important indicator of future extreme price movements. However, after controlling for implied volatility levels, other factors, particularly firm age and size, still have additional predictive power of extreme future returns. Furthermore, excluding predicted extreme return stocks leads to a portfolio that has lower risk (standard deviation of returns) without sacrificing performance.
Number of Pages in PDF File: 29
Keywords: predicting extreme returns
JEL Classification: G10, G14, G17working papers series
Date posted: January 20, 2011 ; Last revised: May 15, 2012
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