Download this Paper Open PDF in Browser

Implied Volatility Sentiment: A Tale of Two Tails

Tinbergen Institute Discussion Paper 17-002/IV

46 Pages Posted: 17 Jan 2017  

Luiz F. F. Felix

VU University Amsterdam

Roman Kräussl

Luxembourg School of Finance; Emory University - Goizueta Business School

Philip A. Stork

VU University Amsterdam - Faculty of Economics and Business Administration; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)

Date Written: January 15, 2017

Abstract

Low probability events are overweighted in the pricing of out-of-the-money index puts and single stock calls. This behavioral bias is strongly time-varying, and is linked to equity market sentiment and higher moments of the risk-neutral density. We find that our implied volatility (IV) sentiment measure, jointly derived from index and single stock options, explains investors’ overweight of tail events well. When employed within a trading strategy, our IV-sentiment measure delivers economically significant results, which are more consistent than the ones produced by the market sentiment factor. Out-of-sample tests on reversal prediction show that our IV-sentiment measure adds value over and above traditional factors in the equity risk premium literature.

Keywords: Sentiment, implied volatility skew, equity-risk premium, reversals, predictability

JEL Classification: G12, G14, G17

Suggested Citation

Felix, Luiz F. F. and Kräussl, Roman and Stork, Philip A., Implied Volatility Sentiment: A Tale of Two Tails (January 15, 2017). Tinbergen Institute Discussion Paper 17-002/IV . Available at SSRN: https://ssrn.com/abstract=2899680

Luiz F. F. Felix (Contact Author)

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Roman Kraeussl

Luxembourg School of Finance ( email )

4, rue Albert Borschette
Luxembourg, 1246
Luxembourg
+3524666445442 (Phone)

HOME PAGE: http://www.art-finance.com

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States
+14042812253 (Phone)
+14047275238 (Fax)

HOME PAGE: http://www.art-finance.com

Philip A. Stork

VU University Amsterdam - Faculty of Economics and Business Administration ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Tinbergen Institute - Tinbergen Institute Amsterdam (TIA) ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Paper statistics

Downloads
234
Rank
109,354
Abstract Views
763