Expected Correlation and Future Market Returns

48 Pages Posted: 6 Mar 2018 Last revised: 4 Jan 2019

See all articles by Adrian Buss

Adrian Buss

INSEAD - Finance; Centre for Economic Policy Research (CEPR)

Lorenzo Schoenleber

Frankfurt School of Finance & Management gemeinnützige GmbH

Grigory Vilkov

Frankfurt School of Finance & Management

Multiple version iconThere are 2 versions of this paper

Date Written: February 2018

Abstract

We document that information about the comovement of individual stocks, jointly extracted from index options and individual stock options, can be used to predict future market excess returns for horizons of up to 1 year, both in-sample and out-of-sample. The predictive power is incremental to that of risk measures exclusively based on the marginal distribution of the market, including (semi)variances and their risk premiums.~We attribute this predictability to the ability of expected correlation to capture expected variations in idiosyncratic risk and in the cross-sectional dispersion in systematic risk. A novel extension of the contemporaneous-beta approach significantly improves out-of-sample predictability.

Keywords: contemporaneous betas, correlation risk premium, expected (implied) correlation, Idiosyncratic Risk, option-implied information, return predictability

JEL Classification: G11, G12, G13, G17

Suggested Citation

Buss, Adrian and Schönleber, Lorenzo and Vilkov, Grigory, Expected Correlation and Future Market Returns (February 2018). CEPR Discussion Paper No. DP12760. Available at SSRN: https://ssrn.com/abstract=3134411

Adrian Buss (Contact Author)

INSEAD - Finance ( email )

Boulevard de Constance
Fontainebleau Cedex, 77305
France
+33 160 72 44 84 (Phone)
+33 160 72 40 45 (Fax)

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

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Lorenzo Schönleber

Frankfurt School of Finance & Management gemeinnützige GmbH ( email )

Sonnemannstraße 9-11
Frankfurt am Main, 60314
Germany

HOME PAGE: http://www.frankfurt-school.de/content/de/who_we_are/staff/schoenleber.html

Grigory Vilkov

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

HOME PAGE: http://www.vilkov.net

Register to save articles to
your library

Register

Paper statistics

Downloads
0
Abstract Views
281
PlumX Metrics