The Information Content in Implied Idiosyncratic Volatility and the Cross-Section of Stock Returns PDF Download
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Author: Dean Diavatopoulos
Publisher:
ISBN:
Category :
Languages : en
Pages : 33
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Book Description
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.
Author: Dean Diavatopoulos
Publisher:
ISBN:
Category :
Languages : en
Pages : 33
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Book Description
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.
Author: Fangjian Fu
Publisher:
ISBN:
Category :
Languages : en
Pages : 45
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Book Description
Theories such as Merton (1987, Journal of Finance) predict a positive relation between idiosyncratic risk and expected return when investors do not diversify their portfolio. Ang, Hodrick, Xing, and Zhang (2006, Journal of Finance 61, 259-299) however find that monthly stock returns are negatively related to the one-month lagged idiosyncratic volatilities. I show that idiosyncratic volatilities are time-varying and thus their findings should not be used to imply the relation between idiosyncratic risk and expected return. Using the exponential GARCH models to estimate expected idiosyncratic volatilities, I find a significantly positive relation between the estimated conditional idiosyncratic volatilities and expected returns. Further evidence suggests that Ang et al.'s findings are largely explained by the return reversal of a subset of small stocks with high idiosyncratic volatilities.
Author: Bernard Dumas
Publisher:
ISBN:
Category : Options (Finance)
Languages : en
Pages : 34
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Book Description
Abstract: Black and Scholes (1973) implied volatilities tend to be systematically related to the option's exercise price and time to expiration. Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) attribute this behavior to the fact that the Black-Scholes constant volatility assumption is violated in practice. These authors hypothesize that the volatility of the underlying asset's return is a deterministic function of the asset price and time and develop the deterministic volatility function (DVF) option valuation model, which has the potential of fitting the observed cross-section of option prices exactly. Using a sample of S & P 500 index options during the period June 1988 through December 1993, we evaluate the economic significance of the implied deterministic volatility function by examining the predictive and hedging performance of the DV option valuation model. We find that its performance is worse than that of an ad hoc Black-Scholes model with variable implied volatilities.
Author: Cesario Mateus
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ISBN:
Category :
Languages : en
Pages : 0
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Book Description
This paper investigates the role of volatility risk on stock return predictability. Using 596 stock options traded at the American Stock Exchange and the Chicago Board Options Exchange (CBOE) for the period from January 2001 to December 2010, it examines the relation between different idiosyncratic volatility measures and expected stock returns for a period that involves both the dotcom bubble and the recent financial crisis. First it is showed that implied idiosyncratic volatility is the best stock return predictor among the different volatility measures used. Second, cross-section firm-specific characteristics are important on stock returns forecast. Third, we provide evidence that higher short selling constraints impact negatively stock returns having liquidity the opposite effect.
Author:
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Category :
Languages : en
Pages :
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Book Description
There has been increasing research on the cross-sectional relation between stock return and volatility. Conclusions are, however, mixed, partially because volatility or variance is modeled or parameterized in various ways. This paper, by using the Jiang and Tian (2005)'s model-free method, estimates daily option implied volatility for all US individual stocks from 1996:01 to 2006:04, and then employs this information to extract monthly volatilities and their idiosyncratic parts for cross-sectional regression analyses. We follow the Fama and French (1992) cross-sectional regression procedure and show that each of the 4 monthly measures of change of total volatility, total volatility, expected idiosyncratic variance, and expected idiosyncratic volatility is a negative priced factor in the cross-sectional variation of stock returns. We also show that the negative correlation between return and total volatility or expected idiosyncratic variance or expected idiosyncratic volatility strengthens as leverage increases or credit rating worsens. However, leverage does not play a role in the relation between return and change of total volatility. Finally, responding to recent papers, we show that the investor sentiment does not have a significant impact on the cross- sectional relation between return and volatility.
Author: Nicole Branger
Publisher:
ISBN:
Category :
Languages : en
Pages : 61
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Book Description
We show that the widely documented negative relation between idiosyncratic volatility (IVOL) and expected returns can be explained by the mean reversion of stocks' idiosyncratic volatilities. We use option-implied information to extract the mean reversion speed of IVOL in an almost model-free fashion. This allows us to identify stocks for which past IVOL is a bad proxy for expected IVOL. These stocks solely drive the negative relation, and a long--short portfolio earns a monthly risk-adjusted return of 2.74%, on average. In a horse race, the mean reversion speed is superior to prominent competing explanations of the IVOL puzzle.
Author: Turan G. Bali
Publisher:
ISBN:
Category :
Languages : en
Pages : 29
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Book Description
This paper examines the cross-sectional relation between idiosyncratic volatility and expected stock returns. The results indicate that (i) data frequency used to estimate idiosyncratic volatility, (ii) weighting scheme used to compute average portfolio returns, (iii) breakpoints utilized to sort stocks into quintile portfolios, and (iv) using a screen for size, price and liquidity play a critical role in determining the existence and significance of a relation between idiosyncratic risk and the cross-section of expected returns. Portfolio-level analyses based on two different measures of idiosyncratic volatility (estimated using daily and monthly data), three weighting schemes (value-weighted, equal-weighted, inverse-volatility-weighted), three breakpoints (CRSP, NYSE, equal-market-share), and two different samples (NYSE/AMEX/NASDAQ and NYSE) indicate that there is no robust, significant relation between idiosyncratic volatility and expected returns.
Author: Seyed Reza Tabatabaei Poudeh
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Category :
Languages : en
Pages :
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Book Description
We examine the relationship between stock returns and components of idiosyncratic volatility-two volatility and two covariance terms- derived from the decomposition of stock returns variance. The portfolio analysis result shows that volatility terms are negatively related to expected stock returns. On the contrary, covariance terms have positive relationships with expected stock returns at the portfolio level. These relationships are robust to controlling for risk factors such as size, book-to-market ratio, momentum, volume, and turnover. Furthermore, the results of Fama-MacBeth cross-sectional regression show that only alpha risk can explain variations in stock returns at the firm level. Another finding is that when volatility and covariance terms are excluded from idiosyncratic volatility, the relation between idiosyncratic volatility and stock returns becomes weak at the portfolio level and disappears at the firm level.
Author: Namho Kang
Publisher:
ISBN:
Category : Stocks
Languages : en
Pages : 0
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Book Description
This paper uncovers the changes in the cross-sectional distribution of idiosyncratic volatility of stocks over the period 1963--2008. The contribution of the top decile to the total market idiosyncratic volatility increased, while the contribution of the bottom decile decreased. We introduce a simple theoretical model showing that larger capital of Long/Short-Equity funds further exacerbates large idiosyncratic shocks but attenuates small idiosyncratic shocks. This effect is stronger for more illiquid stocks. Time-series and cross-sectional results are consistent with the predictions of the model. The results are robust to industry affiliation, stock liquidity, firm size, firm leverage, as well as sign of price change. These findings highlight the roll of hedge funds and other institutional investors in explaining the dynamics of extreme realizations in the cross-section of returns.
Author: George J. Jiang
Publisher:
ISBN:
Category :
Languages : en
Pages : 28
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Book Description
This paper uses adverse selection in corporate information disclosure to explain a recently documented asset pricing anomaly. Ang, Hodrick, Xing, and Zhang (2006a) show that stocks with high idiosyncratic return volatilities tend to have low future returns. In this paper, we find that idiosyncratic volatility is also inversely related to future earning shocks. More importantly, we show that the return predictive power of idiosyncratic volatility is induced by its information content on future earnings. We provide empirical results to support our explanation that firms with poor prospect of future earnings tend to disclose less information, resulting in a higher degree of heterogeneity in investors beliefs, which in turn leads to higher stock return volatility and trading volume. Further analysis suggests that investors tend to underreact to earnings information in idiosyncratic volatility, and the mispricing of idiosyncratic volatility is inversely related to both investor sophistication and stock liquidity.
