Implied Volatility and Future Portfolio Returns

28 Pages Posted: 21 Apr 2006 Last revised: 26 Feb 2009

James Doran

Implied Capital Advisors

Prithviraj Banerjee

Florida State University - Department of Finance

David R. Peterson

Florida State University - Department of Finance

Date Written: December 4, 2006

Abstract

Prior studies find that the CBOE Volatility Index (VIX) predicts returns on broad stock market indices. This is an important finding because it suggests implied volatilities measured by VIX are a risk factor affecting security returns or an indicator of market inefficiency. We extend prior work in three important ways. First, we examine portfolios sorted on book-to-market equity, size, and beta to see if VIX's predictive ability is pervasive across different portfolios. Second, we include deviations of VIX from recent means in addition to VIX levels. Third, we control for the four Fama and French (1993) and Carhart (1997) factors MKT, SMB, HML, and UMD. We find that VIX-related variables have strong predictive ability, suggesting an important role for VIX in security returns.

Keywords: Risk Premium, Implied Volatility, VIX Index, Portfolio Returns

JEL Classification: G11, G12

Suggested Citation

Doran, James and Banerjee, Prithviraj and Peterson, David R., Implied Volatility and Future Portfolio Returns (December 4, 2006). Journal of Banking and Finance, Vol. 31, October 2007. Available at SSRN: https://ssrn.com/abstract=896704

James Doran (Contact Author)

Implied Capital Advisors ( email )

1942 Broadway Suite 409
Boulder, CO 80302
United States

Prithviraj Banerjee

Florida State University - Department of Finance ( email )

Tallahassee, FL 32306-1042
United States

David R. Peterson

Florida State University - Department of Finance ( email )

Tallahassee, FL 32306-1042
United States
850-644-8200 (Phone)
850-644-4225 (Fax)

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