41 Pages Posted: 31 Oct 2019 Last revised: 5 Dec 2019
Date Written: October 31, 2019
We extract subjective risk-neutral and physical distributions from option quotes on S&P500 and VIX futures according to agents' sentiment without assumptions on preferences or underlying processes. Beliefs are crucial for the recovered distributions and the change of measure. The recovered joint distributions imply marginal distributions markedly different from conventional univariate approaches. Using expected volatility as the second dimension allows to differentiate economic states more precisely by taking future investment opportunities into account. With these distributions at hand, we devise optimal Sharpe ratio trading strategies in S&P500 and VIX futures markets that are subjective to the agents, and implement them at the observed quotes. The bivariate distributions define important investment opportunities that would not be available considering the two markets separately. Dispersion of beliefs regarding both market and volatility dynamics is related to, and predicts macroeconomic indicators.
Keywords: Recovery, sentiment, market views, volatility trading, market spanning
JEL Classification: G11, G12, G13, G17
Suggested Citation: Suggested Citation