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University of Nebraska - Lincoln
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The Relationship Between The Option-Implied Volatility Smile, Stock Returns And Heterogeneous Beliefs, Shu Feng, Yi Zhang, Geoffrey C. Friesen
The Relationship Between The Option-Implied Volatility Smile, Stock Returns And Heterogeneous Beliefs, Shu Feng, Yi Zhang, Geoffrey C. Friesen
Department of Finance: Faculty Publications
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.