Implied volatility sentiment: a tale of two tails
- Low probability events are overweighted in the pricing of out-of the-money index puts and single stock calls. We find that this behavioral bias is strongly time-varying, linked to equity market sentiment, and higher moments of the risk-neutral density. An implied volatility (IV) sentiment measure that is jointly derived from index and single stock options explains investors' overweight of tail events the best. Our findings also suggest that IV-sentiment predicts equity markets reversals better than overweight of small probabilities itself. When employed in a trading strategy, IV-sentiment delivers economically significant results, which are more consistent than the ones produced by the market sentiment factor. The joint use of information from the single stock and index option markets seems to explain the forecasting power of IV-sentiment. Out-of-sample tests on reversal prediction show that our IV-sentiment measure adds value over and above traditional factors in the equity risk premium literature, especially as an equity-buying signal. This reversals prediction seems to improve time-series and cross-sectional momentum strategies.
Author: | Luiz Félix, Roman KräusslORCiDGND, Philip Stork |
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URN: | urn:nbn:de:hebis:30:3-427191 |
URL: | https://www.ifk-cfs.de/fileadmin/downloads/publications/wp/2016/CFS_WP_565.pdf |
Parent Title (English): | Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 565 |
Series (Serial Number): | CFS working paper series (565) |
Publisher: | Center for Financial Studies |
Place of publication: | Frankfurt, M. |
Document Type: | Working Paper |
Language: | English |
Year of Completion: | 2017 |
Year of first Publication: | 2017 |
Publishing Institution: | Universitätsbibliothek Johann Christian Senckenberg |
Release Date: | 2017/01/31 |
Tag: | equity-risk premium; implied volatility skew; predictability; reversals; sentiment |
Issue: | January 2017 |
Page Number: | 50 |
HeBIS-PPN: | 400130246 |
Institutes: | Wirtschaftswissenschaften / Wirtschaftswissenschaften |
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS) | |
Dewey Decimal Classification: | 3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft |
Sammlungen: | Universitätspublikationen |
Licence (German): | Deutsches Urheberrecht |