Aggregate Implied Volatility Spread and Stock Market Returns
44 Pages Posted: 4 Oct 2017 Last revised: 23 Jan 2018
Date Written: September 1, 2017
This paper documents a new and robust predictor of stock market returns and real economic activities based on information from the equity options. The aggregate implied volatility spread (IVS), defined as the average difference in implied volatilities of at-the-money call and put options on stocks, is significantly and positively related to future stock market returns from daily, monthly to semi-annual horizons. This predictive power is significant both in-sample and out-of-sample. Additional tests suggest that the predictive power of aggregate IVS is more consistent with common informed trading in equity options instead of time-varying risk premium.
Keywords: stock return predictability, implied volatility spread, macroeconomic forecasts, informed trading in options, limits to arbitrage
JEL Classification: G12, G13, G14, G17
Suggested Citation: Suggested Citation