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Corridor Volatility Risk and Expected Returns

27 Pages Posted: 9 Feb 2013  

George Dotsis

University of Athens - Faculty of Economics; Essex Finance Centre, Essex Business School, University of Essex

Nikolaos Vlastakis

Essex Business School, University of Essex

Date Written: February 8, 2013

Abstract

In this paper we examine the pricing of volatility risk using SPX corridor implied volatility. We decompose model-free total implied volatility into various components using different segments of the cross section of out-of-the money put and call option prices. We find that only model-free volatility computed from the cross section of out-of-the-money call option prices carries a significant negative risk premium in the cross section of stock returns and also contains all relevant information for forecasting future volatility risk. Overall, our empirical results provide strong evidence that SPX out-of-the money put option prices do not contain useful information for capturing systematic volatility risk in equity returns.

Keywords: corridor implied volatility, tail risk, cross-section of stock returns

JEL Classification: G10, G12

Suggested Citation

Dotsis, George and Vlastakis, Nikolaos, Corridor Volatility Risk and Expected Returns (February 8, 2013). Available at SSRN: https://ssrn.com/abstract=2213900 or http://dx.doi.org/10.2139/ssrn.2213900

George Dotsis (Contact Author)

University of Athens - Faculty of Economics ( email )

Greece

HOME PAGE: http://sites.google.com/site/gdotsis/

Essex Finance Centre, Essex Business School, University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Nikolaos Vlastakis

Essex Business School, University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

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