Volatility Spreads and Expected Stock Returns

Management Science, Forthcoming

32 Pages Posted: 4 Aug 2009  

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business

Armen Hovakimian

Baruch College - Zicklin School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: June 17, 2009

Abstract

This paper investigates whether realized and implied volatilities of individual stocks can predict the cross-sectional variation in expected returns. Although the levels of volatilities from the physical and risk-neutral distributions cannot predict future returns, there is a significant relation between volatility spreads and expected stock returns. Portfolio level analyses and firm-level cross-sectional regressions indicate a negative and significant relation between expected returns and the realized-implied volatility spread that can be viewed as a proxy for volatility risk. The results also provide evidence for a significantly positive link between expected returns and the call-put options’ implied volatility spread that can be considered as a proxy for jump risk. The parameter estimates from the VAR-bivariate- GARCH model indicate significant information flow from individual equity options to individual stocks, implying informed trading in options by investors with private information.

Keywords: realized volatility, implied volatility, volatility risk, jump risk, stock returns

JEL Classification: G10, G11, G12, G14

Suggested Citation

Bali, Turan G. and Hovakimian, Armen, Volatility Spreads and Expected Stock Returns (June 17, 2009). Management Science, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1443848

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: http://faculty.msb.edu/tgb27/

Armen Hovakimian (Contact Author)

Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-225
New York, NY 10010
United States
646-312-3490 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/ahovakimian/

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