Which Explains an Equity Index’s Return Better, the Change in its Own Implied Volatility or that for a Broader Index?

Journal Of Investment Management (JOIM), Third Quarter 2009

Posted: 13 Oct 2009

See all articles by Susana Yu

Susana Yu

Iona College

Dean Leistikow

Fordham University - Finance Area

Date Written: October 7, 2009

Abstract

This study examines the proper risk proxy for an equity index. For each of nine indexes, an implied volatility index (VI) is computed from its options. For each, it determines whether the indexes’ return is explained better by the contemporaneous change in its own VI or that for a broader index. Overall, the broader indexes’ VI explains the indexes’ contemporaneous return better. We also find that the difference between the broader indexes’ VI and the individual indexes’ VI contributes to explaining the indexes’ contemporaneous return. Finally, we determine that the forward return differential between the indexes’ returns associated with high and low VI quintiles ranked by both the indexes’ VI and the broader indexes’ VI is positive. We also find that the differential is higher when ranked by the broader indexes’ VI.

Keywords: Implied volatility, risk indicator, trading strategies

JEL Classification: G00

Suggested Citation

Yu, Susana and Leistikow, Dean, Which Explains an Equity Index’s Return Better, the Change in its Own Implied Volatility or that for a Broader Index? (October 7, 2009). Journal Of Investment Management (JOIM), Third Quarter 2009. Available at SSRN: https://ssrn.com/abstract=1484957

Susana Yu (Contact Author)

Iona College ( email )

715 North Avenue
New Rochelle, NY 10801
United States

Dean Leistikow

Fordham University - Finance Area ( email )

33 West 60th Street
New York, NY 10023
United States

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