The Sum of All Fears: Forecasting International Returns using Option-implied Risk Measures

46 Pages Posted: 28 Dec 2017 Last revised: 4 Mar 2020

See all articles by Marie-Hélène Gagnon

Marie-Hélène Gagnon

Université Laval - Faculté d'Administration

Gabriel Power

Université Laval - Département de Finance et Assurance

Dominique Toupin

Bishop’s University - Williams School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: April 1, 2017

Abstract

This paper investigates international index return predictability using daily-updated option-implied information in predictive regressions and out-of-sample forecasts. We document the significant predictive power of the variance risk premium (VRP), Generalized Riskiness (GR), and higher-order moments for horizons ranging from 1 to 250 days. These four risk metrics, which capture cumulative market “fears”, perform well in the US and internationally. VRP and GR are significant and complementary predictors for several horizons, including under one month (VRP) and longer horizons (GR). Risk-neutral skewness and kurtosis are significant for several countries across multiple horizons. Utility gain calculations confirm the economic significance of these risk-neutral variables internationally.

Keywords: Options, risk-neutral distribution, variance risk premium, return predictability, predictive regressions, international stock market returns, generalized riskiness, higher-order moments, skewness

JEL Classification: C12, C22, G12, G13

Suggested Citation

Gagnon, Marie-Hélène and Power, Gabriel and Toupin, Dominique, The Sum of All Fears: Forecasting International Returns using Option-implied Risk Measures (April 1, 2017). Available at SSRN: https://ssrn.com/abstract=3091953 or http://dx.doi.org/10.2139/ssrn.3091953

Marie-Hélène Gagnon

Université Laval - Faculté d'Administration ( email )

Quebec G1K 7P4
Canada

Gabriel Power (Contact Author)

Université Laval - Département de Finance et Assurance ( email )

Pavillon Palasis-Prince
Quebec G1K 7P4
Canada

Dominique Toupin

Bishop’s University - Williams School of Business ( email )

Canada

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