Jump risk, stock returns, and slope of implied volatility smile

Predictability and Predictors of Volatility Smirk: A Study on Index Options

“…Unlike previous studies (see Xing et al 2010, Yan 2011, this paper, interestingly, finds that smirk displays positive causal relationship with marginal index returns. The results are consistent even after controlling for major risk factors.…”

“…They further examine the predicting ability of volatility smirk for future stock returns and report that stocks with flatter smirks outperform those with steepest smirks, on a risk-adjusted basis. Yan (2011) examine the predicting ability of implied volatility smile for future stock returns using a sample of four thousand stocks during the period of 1996-2005. The author reports a negative relationship between the slope of implied volatility smile and stock re turns.…”

The relationship between the option-implied volatility smile, stock returns and heterogeneous beliefs

“…Similar to Yan (2011),we use the fitted implied volatility for 1-month maturity as our variable of implied volatility. OptionMetrics computes the fitted implied volatility for various maturities and option deltas based on the binomial model of Cox, Ross, and Rubinstein (1979) and kernel smoothing technique.…”

“…3 We follow previous studies (e.g. Yan, 2011) to decompose the smile slope into systematic and idiosyncratic components using the smile slope of S&P 500 index option to proxy for the market smile slope. The put (call) slope of stock options is regressed on the put (call) slope of S&P 500 index options with a maturity of 1-month to obtain the systematic and idiosyncratic component of the smile slope.…”

“…To further test our hypothesis about belief differences, we follow Yan (2011) and decompose the smile slope into systematic and idiosyncratic components. An et al (2014) find that the change in the idiosyncratic component of implied volatility is the source of stock return predictability.…”