28 Pages Posted: 21 Apr 2006 Last revised: 26 Feb 2009
Date Written: December 4, 2006
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: 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
By David Bates