Option-Implied Volatility Measures and Stock Return Predictability
Posted: 20 May 2019 Last revised: 9 Aug 2019
Date Written: April 14, 2016
Using firm-level option and stock data, we examine the predictive ability of option-implied volatility measures proposed by previous studies and recommend the best measure using up-to-date data. Portfolio level analysis implies significant non-zero risk-adjusted returns on arbitrage portfolios formed on the call-put implied volatility spread, implied volatility skew, and realized-implied volatility spread. Firm-level cross-sectional regressions show that, the implied volatility skew has the most significant predictive power over various investment horizons. The predictive power persists before and after the 2008 Global Financial Crisis.
Keywords: option-implied volatility, volatility skew, return predictability
JEL Classification: G11, G12
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