Predicting the Equity Market with Option-Implied Variables
European Journal of Finance (2019), Vol. 25(10), pp. 937–965
63 Pages Posted: 22 Nov 2017 Last revised: 18 Sep 2019
Date Written: November 13, 2018
We comprehensively analyze the predictive power of several option-implied variables for monthly S&P 500 excess returns and realized variance. The correlation risk premium (CRP) and the variance risk premium (VRP) emerge as strong predictors of both excess returns and realized variance. This is true both in- and out-of-sample. Our results also reveal that statistical evidence of predictability does not necessarily lead to economic gains. However, a timing strategy based on the CRP leads to utility gains of more than 5.03% per annum. Forecast combinations provide stable forecasts for both excess returns and realized variance, and add economic value.
Keywords: Equity Premium, Option Implied Information, Portfolio Choice, Predictability, Timing Strategies
JEL Classification: G10, G11, G17
Suggested Citation: Suggested Citation