Improving Portfolio Selection Using Option-Implied Volatility and Skewness

49 Pages Posted: 1 Mar 2010

See all articles by Victor DeMiguel

Victor DeMiguel

London Business School

Yuliya Plyakha

Universite du Luxembourg - School of Finance

Raman Uppal

EDHEC Business School; Centre for Economic Policy Research (CEPR)

Grigory Vilkov

Frankfurt School of Finance & Management

Multiple version iconThere are 2 versions of this paper

Date Written: February 2010

Abstract

Our objective in this paper is to examine whether one can use option-implied information to improve mean-variance portfolio selection with a large number of stocks, and to document which aspects of option-implied information are most useful for improving the out-of-sample performance of mean-variance portfolios. To calculate the optimal mean-variance portfolio weights, one needs to estimate for each stock its volatility, correlations with all other stocks, and expected return. Our empirical evidence shows that, while using the option-implied volatilities and correlations does not improve significantly the portfolio variance, Sharpe ratio, and certainty-equivalent return, exploiting information about expected returns that is contained in the volatility risk premium and option-implied skewness increases substantially Sharpe ratios and certainty-equivalent returns, but this is accompanied by higher portfolio turnover.

Keywords: mean-variance, option-implied skewness, option-implied volatility, portfolio optimization, variance risk premium

JEL Classification: G11, G12, G13, G17

Suggested Citation

DeMiguel, Victor and Plyakha, Yuliya and Uppal, Raman and Vilkov, Grigory, Improving Portfolio Selection Using Option-Implied Volatility and Skewness (February 2010). CEPR Discussion Paper No. DP7686. Available at SSRN: https://ssrn.com/abstract=1559642

Victor DeMiguel (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Yuliya Plyakha

Universite du Luxembourg - School of Finance ( email )

4 Rue Albert Borschette
Luxembourg, L-1246
Luxembourg

Raman Uppal

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

Centre for Economic Policy Research (CEPR)

90-98 Goswell Road
London, EC1V 7RR
United Kingdom

Grigory Vilkov

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

HOME PAGE: http://www.vilkov.net

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