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

Shu Feng, Yi Zhang, Geoffrey C. Friesen

Research output: Contribution to journalArticlepeer-review

7 Scopus citations

Abstract

We study the relationship between stock returns and the implied volatility smile slope of call and put options. Stocks with a steeper put slope earn lower future returns, while stocks with a steeper call slope earn higher future returns. Using dispersion of opinion as a proxy for belief differences, we find that the slope-stock return relation is strongest for stocks with high belief differences. The idiosyncratic component of the put slope fully explains the negative risk-adjusted stock returns. For the call slope, the idiosyncratic component dominates the systematic one, and explains the positive risk-adjusted returns.

Original languageEnglish (US)
Pages (from-to)62-73
Number of pages12
JournalInternational Review of Financial Analysis
Volume41
DOIs
StatePublished - Oct 1 2015

Keywords

  • Heterogeneous beliefs
  • Implied volatility
  • Smile slope

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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