Aggregate Implied Volatility Spread and Stock Market Returns

59 Pages Posted: 4 Oct 2017 Last revised: 22 Nov 2021

See all articles by Bing Han

Bing Han

University of Toronto, Rotman School of Management

Gang Li

The Chinese University of Hong Kong, CUHK Business School

Date Written: September 1, 2017

Abstract

Aggregate implied volatility spread (IVS), defined as the cross-sectional average difference in the implied volatilities of at-the-money call and put equity options, is significantly and positively related to future stock market returns at daily, weekly, monthly, to semiannual horizons. This return predictive power is incremental to existing return predictors and is significant both in sample and out of sample. Furthermore, IVS can forecast macroeconomic news up to one year ahead. The return predictability concentrates around macro news announcement. Common informed trading in equity options offers an integrated explanation for the ability of IVS to predict both future stock market returns and real economic activity.

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, International Journal of Information Systems & Management Science, Vol. 67, No. 2, 2021, 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

The Chinese University of Hong Kong, CUHK Business School ( email )

Cheng Yu Tung Building, 12 Chak Cheung Street
Shatin
Hong Kong

HOME PAGE: http://sites.google.com/view/ganglihk

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