The Information Content of the Implied Volatility Term Structure on Future Returns

Abstract

We derive the theoretical relation between the term structure of implied variance and the expected excess returns of the underlying asset. Adopting three alternative approaches to compile the variables representing the information on the implied volatility index level and term structure, we show the important role of the term structure in determining future excess returns of the S&P 500 index. Both the in-sample and out-of-sample analyses suggest that the information content of the term structure variable is significant and a strong complement to that of the level variable, especially for shorter-term excess returns.

Keywords: VIX term structure, Predictability, S&P 500 index returns

JEL Classification: G13, G14