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

See all articles by Fabian Hollstein

Fabian Hollstein

Leibniz University Hannover - School of Economics and Management

Marcel Prokopczuk

Leibniz Universität Hannover - Faculty of Economics and Management; University of Reading - ICMA Centre

Björn Tharann

Leibniz Universität Hannover

Chardin Wese Simen

University of Liverpool Management School

Date Written: November 13, 2018

Abstract

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

Hollstein, Fabian and Prokopczuk, Marcel and Tharann, Björn and Wese Simen, Chardin, Predicting the Equity Market with Option-Implied Variables (November 13, 2018). European Journal of Finance (2019), Vol. 25(10), pp. 937–965, Available at SSRN: https://ssrn.com/abstract=3070353 or http://dx.doi.org/10.2139/ssrn.3070353

Fabian Hollstein

Leibniz University Hannover - School of Economics and Management ( email )

Koenigsworther Platz 1
Hannover, 30167
Germany

Marcel Prokopczuk

Leibniz Universität Hannover - Faculty of Economics and Management ( email )

Koenigsworther Platz 1
Hannover, 30167
Germany

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

Björn Tharann (Contact Author)

Leibniz Universität Hannover ( email )

Welfengarten 1
D-30167 Hannover, 30167
Germany

Chardin Wese Simen

University of Liverpool Management School ( email )

Management School
University of Liverpool
Liverpool, L69 7ZH
United Kingdom

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