Past Managerial Guidance and Returns to Variance Trading around Earnings Announcements

Abstract

I investigate the relationship between past managerial guidance and realized variance risk premiums (VRPs) – i.e., the difference between implied and realized variance – in equity options around earnings announcements. I find that implied variances are lower before earnings announcements but VRPs are higher when firms provide guidance. I also find higher option-implied jump risk when firms issue surprising guidance. Further tests suggest a portion of the higher VRPs is due to changes in perceived higher-order risks, but traders also underreact to the precision of information in short-term guidance. These results are attenuated for firms with a better information environment.

Keywords: management forecasts, voluntary disclosure, variance risk premium, kurtosis, implied variance

JEL Classification: M4