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The information content in implied idiosyncratic volatility and the cross-section of stock returns: Evidence from the option markets

✍ Scribed by Dean Diavatopoulos; James S. Doran; David R. Peterson

Publisher: John Wiley and Sons
Year: 2008
Tongue: English
Weight: 266 KB
Volume: 28
Category: Article
ISSN: 0270-7314
DOI: 10.1002/fut.20327

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✦ Synopsis

Abstract

Current literature is inconclusive as to whether idiosyncratic risk influences future stock returns and the direction of the impact. Earlier 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. Implied idiosyncratic volatilities on firms with traded options are used to examine the relationship between idiosyncratic volatility and future returns. A strong positive link was found 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. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28: 1013–1039, 2008

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