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Implied Volatility Indices as Leading Indicators of Stock Index Returns?

CORE Discussion Paper No. 2002/50

35 Pages Posted: 27 Feb 2003  

Pierre Giot

Facult├ęs Universitaires Notre-Dame de la Paix (FUNDP)

Date Written: September 2002

Abstract

This paper shows that, when the VIX or VXN indices of implied volatility increase, the S&P100 and NASDAQ100 stock indices exhibit on average negative returns, hence the 'fear factor' associated with high levels of implied volatility in financial markets. However, attractive (from a mean-variance perspective) positive returns should then be expected on average in the immediate short-term. In this framework, very high levels of implied volatility can on a statistical basis be viewed as signalling an imminent increase in stock indices, at least on a short term basis. Our analysis also shows that average to moderately high levels of implied volatility lead to unfavorable (from a mean-variance perspective) returns. Thus traders willing to enter 'oversold' markets should wait until extremely high levels of implied volatility are witnessed, and their strategy should be strictly on a short-term basis.

Keywords: Implied volatility, VIX index, trading, return and risk

Suggested Citation

Giot, Pierre, Implied Volatility Indices as Leading Indicators of Stock Index Returns? (September 2002). CORE Discussion Paper No. 2002/50. Available at SSRN: https://ssrn.com/abstract=371461 or http://dx.doi.org/10.2139/ssrn.371461

Pierre Giot (Contact Author)

Facult├ęs Universitaires Notre-Dame de la Paix (FUNDP) ( email )

Rempart de la Vierge 8
B-5000 Namur
Belgium

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