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Media type:
E-Article
Title:
The Only Constant Is Change: Nonconstant Volatility and Implied Volatility Spreads
Contributor:
Campbell, T. Colin;
Gallmeyer, Michael;
Petkevich, Alex
imprint:
Cambridge University Press (CUP), 2023
Published in:Journal of Financial and Quantitative Analysis
Language:
English
DOI:
10.1017/s0022109023000182
ISSN:
1756-6916;
0022-1090
Origination:
Footnote:
Description:
<jats:title>Abstract</jats:title><jats:p>We examine the predictability of stock returns using implied volatility spreads (VS) from individual (nonindex) options. VS can occur under simple no-arbitrage conditions for American options when volatility is time-varying, suggesting that the VS-return predictability could be an artifact of firms’ sensitivities to aggregate volatility. Examining this empirically, we find that the predictability changes systematically with aggregate volatility and is positively related to the firms’ sensitivities to volatility risk. The alpha generated by VS hedge portfolios can be explained by aggregate volatility risk factors. Our results cannot be explained by firm-specific informed trading, transaction costs, or liquidity.</jats:p>