Option-Implied Volatility-Managed Asset Pricing Risk Factors and Resurrection of the Value Factor

Abstract

Option-implied volatility-managed risk factor models produce higher maximum squared Sharpe ratios than the recently proposed six-factor model, which is used as a benchmark model in this study. A model that incorporates option-implied volatility-managed risk factors based on dynamic scaling factors that systematically overestimate the expected market risk, as measured by the VIX, is superior to other asset pricing model specifications. After the death of the value factor has been repeatedly declared, it is surprising news that multivariate spanning regressions reveal that both the option-implied volatility-managed momentum and value factor are the only option-implied volatility-managed risk factors that generate alpha and that are therefore the cause of the asset pricing model’s superiority.

Keywords: option-implied volatility, risk factors, asset pricing models, volatility-managing

JEL Classification: G12, G14