Implied Volatility Spreads, Skewness and Expected Market Returns

34 Pages Posted: 25 Nov 2009 Last revised: 2 Jul 2016

Yigit Atilgan

Sabanci University

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business

K. Ozgur Demirtas

Sabanci University

Date Written: July 14, 2010

Abstract

This paper investigates the intertemporal relation between implied volatility spreads and expected returns on the aggregate stock market. The results show a signifi…cantly negative link between expected future returns and the spread between the implied volatilities of out-of-the-money put and at-the-money call options written on the S&P 500 index. We argue that this relation is driven by information flow from option markets to stock markets rather than volatility spreads acting as a proxy for skewness. First, neither physical nor risk-neutral skewness can predict expected aggregate returns. Second, the relation between volatility spreads and expected market returns is signi…ficantly stronger for the periods that S&P 500 constituent …firms announce their earnings and for the periods that consumer sentiment index is extremely high or low. The intertemporal relation between volatility spreads and expected market returns remains strongly negative after controlling for various measures of conditional volatility, a large set of macroeconomic variables, small sample biases, and distributional assumptions.

Keywords: implied volatility spreads, conditional skewness, expected market return, information ‡flow, intertemporal risk-return relation

JEL Classification: G10, G11, G12, C13, E32, E37

Suggested Citation

Atilgan, Yigit and Bali, Turan G. and Demirtas, K. Ozgur, Implied Volatility Spreads, Skewness and Expected Market Returns (July 14, 2010). Georgetown McDonough School of Business Research Paper No. 1511970. Available at SSRN: https://ssrn.com/abstract=1511970 or http://dx.doi.org/10.2139/ssrn.1511970

Yigit Atilgan

Sabanci University ( email )

Orta Mahalle Üniversite Caddesi 27
Istanbul, Orhanli, 34956 Tuzla 34956
Turkey

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://msbonline.georgetown.edu/faculty-research/msf-faculty/turan-bali

K. Ozgur Demirtas (Contact Author)

Sabanci University ( email )

Graduate School of Management
Orhanli Tuzla
İstanbul, 34956
Turkey
(+90) 216-483-9985 (Phone)
(+90) 216-483-9699 (Fax)

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