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Does the volatility of volatility risk forecast future stock returns?

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  • Bu, Ruijun
  • Fu, Xi
  • Jawadi, Fredj

Abstract

This study investigates whether the forward-looking volatility of aggregate volatility (VOV) risk forecasts future stock returns in the US equity market. We find that stocks with higher sensitivities to changes in VOV constructed from VIX options have higher future returns than those with lower sensitivities. In particular, VOV constructed from deep out-of-the-money put options has the strongest predictive power, and the strongest predictability of VOV betas is found for investment horizons between 10-day to 1-month. Our findings are robust after considering estimation uncertainty of VOV betas and controlling for common pricing factors.

Suggested Citation

  • Bu, Ruijun & Fu, Xi & Jawadi, Fredj, 2019. "Does the volatility of volatility risk forecast future stock returns?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 61(C), pages 16-36.
    • Handle: RePEc:eee:intfin:v:61:y:2019:i:c:p:16-36
    DOI: 10.1016/j.intfin.2019.02.001
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    More about this item

    Keywords

    Stock return predictability; VIX options; Volatility of volatility; CBOE VVIX; Corridor VVIX;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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