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Revisiting VIX as Stock Return Predictor

Posted in Equity Premium, Volatility Effects

Does implied stock market volatility (IV) predict stock market returns? In their March 2018 paper entitled "Implied Volatility Measures As Indicators of Future Market Returns", Roberto Bandelli and Wenye Wang analyze the relationship between S&P 500 Index IV and future S&P 500 Index returns. They consider volatilities implied either by S&P 500 Index options (VIX) or by 30-day at-the-money S&P 500 Index straddles. Specifically, they each day:

  1. Rank current S&P 500 Index IV according to ranked tenth (decile) of its daily distribution over the past two years. If current IV is higher than any value of IV over the past two years, its rank is 11.
  2. Calculate S&P 500 Index returns over the next one, five and 20 trading days.
  3. Relate these returns to IV rank.

They calculate statistical significance based on the difference between the average IV-ranked log returns and log returns over all intervals of the same length. Using daily data for the selected variables during December 1991 through November 2017, they find that:

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