Implied Volatility Measures As Indicators of Future Market Returns
11 Pages Posted: 9 May 2018 Last revised: 23 Jan 2019
Date Written: January 2019
We analyze the relationship between implied volatility and subsequent equity markets excess returns. We find that high readings of implied volatility have a strong correlation with positive and economically sizable returns in the subsequent 1, 5, and 20 trading days. Mid-level readings are generally associated with returns which are statistically positive but not economically significant. Low readings show a statistically meaningful link with negative but economically small returns. We also document that the statistical relationship with equity markets behavior is stronger when using the VIX as a measure of implied volatility instead of the implied volatility of at-the-money straddles.
Keywords: VIX, volatility, market returns, IV
JEL Classification: C1, G1
Suggested Citation: Suggested Citation