Aggregate Implied Volatility Spread and Stock Market Returns

44 Pages Posted: 4 Oct 2017 Last revised: 23 Jan 2018

See all articles by Bing Han

Bing Han

University of Toronto, Rotman School of Management

Gang Li

University of Toronto - Rotman School of Management

Date Written: September 1, 2017

Abstract

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

Han, Bing and Li, Gang, Aggregate Implied Volatility Spread and Stock Market Returns (September 1, 2017). Rotman School of Management Working Paper No. 3047528; Asian Finance Association (AsianFA) 2018 Conference. Available at SSRN: https://ssrn.com/abstract=3047528 or http://dx.doi.org/10.2139/ssrn.3047528

Bing Han (Contact Author)

University of Toronto, Rotman School of Management ( email )

Toronto, Ontario M5S 3E6
Canada
4169460732 (Phone)

Gang Li

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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