23 Pages Posted: 13 Dec 2012 Last revised: 16 Mar 2016
Date Written: October 12, 2012
I examine the relationship between aggregate news sentiment, S&P 500 Index returns, and changes in the implied volatility index (VIX). I find a significant negative contemporaneous relationship between changes in VIX and both news sentiment and stock returns. This relationship is asymmetric whereby changes in VIX are larger following negative news and/or stock market declines. VAR analysis of the dynamics and cross-dependencies between variables reveals a strong positive relationship between previous and current period changes in implied volatility and stock returns, while current period and lagged news sentiment has a significant positive (negative) relationship with stock returns (changes in VIX). I develop a simple trading strategy whereby high (low) levels of implied volatility signal attractive opportunities to take long (short) positions in the underlying index, while extremely negative (positive) news sentiment signals opportunities to enter short (long) index positions.
Keywords: VIX, VAR, News Sentiment, S&P500, Equity
JEL Classification: G1, G10, G14
Suggested Citation: Suggested Citation
Smales, Lee A., Time-Varying Relationship of News Sentiment, Implied Volatility and Stock Returns (October 12, 2012). Applied Economics, Forthcoming; Asian Finance Association (AsFA) 2013 Conference. Available at SSRN: https://ssrn.com/abstract=2186267 or http://dx.doi.org/10.2139/ssrn.2186267