Implied Volatility Sentiment: A Tale of Two Tails

Arbeitspapier

Low probability events are overweighted in the pricing of out-of-the-money index puts and single stock calls. This behavioral bias is strongly time-varying, and is linked to equity market sentiment and higher moments of the risk-neutral density. We _nd that our implied volatility (IV) sentiment measure, jointly derived from index and single stock options, explains investors' overweight of tail events well. When employed within a trading strategy, our IV-sentiment measure delivers economically signi_cant results, which are more consistent than the ones produced by the market sentiment factor. 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.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Tinbergen Institute Discussion Paper ; No. 17-002/IV

Classification and Topics

• Classification: Wirtschaft ; Asset Pricing; Trading Volume; Bond Interest Rates ; Information and Market Efficiency; Event Studies; Insider Trading ; Financial Forecasting and Simulation
• Subject: Sentiment ; implied volatility skew ; equity-risk premium ; reversals ; predictability

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Stork, Philip ; Félix, Luiz ; Kräussl, Roman
• Event: Veröffentlichung
• (who): Tinbergen Institute
• (where): Amsterdam and Rotterdam
• (when): 2017

Further information

• Handle: http://hdl.handle.net/10419/149516
• Last update: 10.03.2025, 11:42 AM CET