The Information Content in Implied Idiosyncratic Volatility and the Cross-Section of Stock Returns: Evidence from the Option Markets

Journal of Futures Markets Vol. 28, pp.1013-1039, October 2008

33 Pages Posted: 30 Dec 2006 Last revised: 15 Dec 2014

See all articles by Dean Diavatopoulos

Dean Diavatopoulos

Seattle University

James Doran

University of New South Wales

David R. Peterson

Florida State University - Department of Finance

Date Written: April 8, 2006

Abstract

Current literature is inconclusive as to whether idiosyncratic risk influences future stock returns and the direction of the impact. Prior studies are based on historical realized volatility. Implied volatilities from option prices represent the market's assessment of future risk and are likely a superior measure to historical realized volatility. We use implied idiosyncratic volatilities on firms with traded options to examine the relation between idiosyncratic volatility and future returns. We find a strong positive link between implied idiosyncratic risk and future returns. After considering the impact of implied idiosyncratic volatility, historical realized idiosyncratic volatility is unimportant. This performance is strongly tied to small size and high book-to-market equity firms.

Keywords: implied volatility, idiosyncratic volatility, portfolio returns

JEL Classification: G11, G12

Suggested Citation

Diavatopoulos, Dean and Doran, James and Peterson, David R., The Information Content in Implied Idiosyncratic Volatility and the Cross-Section of Stock Returns: Evidence from the Option Markets (April 8, 2006). Journal of Futures Markets Vol. 28, pp.1013-1039, October 2008. Available at SSRN: https://ssrn.com/abstract=954249

Dean Diavatopoulos

Seattle University ( email )

901 12th Avenue
Seattle, WA 98122
United States

James Doran (Contact Author)

University of New South Wales ( email )

College Rd
Sydney, NSW 2052
Australia

David R. Peterson

Florida State University - Department of Finance ( email )

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

Register to save articles to
your library

Register

Paper statistics

Downloads
1,190
Abstract Views
4,258
rank
16,431
PlumX Metrics