Cross-Section Stock Return and Implied Covariance between Jump and Diffusive Volatility

I examine the information content of option‐implied covariance between jumps and diffusive risk in the cross‐sectional variation in future returns. This paper documents that the difference between realized volatility and implied covariance (RV‐ICov) can predict future returns. The results show a sig...

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Bibliographic Details
Published inJournal of forecasting Vol. 34; no. 5; pp. 379 - 390
Main Author Ze-To, Samuel Y.M.
Format Journal Article
LanguageEnglish
Published Chichester Blackwell Publishing Ltd 01.08.2015
Wiley Periodicals Inc
Subjects
Capital returns
cross-sectional stock return
Expected returns
Financial information
implied volatility
option-implied covariance
Portfolio analysis
Portfolio investments
Regression analysis
Securities trading
Spread
Stock returns
Studies
Volatility
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Summary:I examine the information content of option‐implied covariance between jumps and diffusive risk in the cross‐sectional variation in future returns. This paper documents that the difference between realized volatility and implied covariance (RV‐ICov) can predict future returns. The results show a significant and negative association of expected return and realized volatility–implied covariance spread in both the portfolio level analysis and cross‐sectional regression study. A trading strategy of buying a portfolio with the lowest RV‐ICov quintile portfolio and selling with the highest one generates positive and significant returns. This RV‐Cov anomaly is robust to controlling for size, book‐to‐market value, liquidity and systematic risk proportion. Copyright © 2015 John Wiley & Sons, Ltd.
Bibliography:istex:CBD4EFD51BBE3B784B6C2D1AF942DF2EA60C2390
ark:/67375/WNG-XPRQZ5GB-D
ArticleID:FOR2348
ObjectType-Article-1
SourceType-Scholarly Journals-1
ObjectType-Feature-2
content type line 23
ISSN:0277-6693
1099-131X
DOI:10.1002/for.2348