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The incremental information content of innovations in implied idiosyncratic volatility

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  • Moll, Cliff R.
  • Huffman, Stephen P.

Abstract

Motivated by mixed evidence related to the pricing of measures of risk, we investigate the information content of innovations in implied idiosyncratic volatility. Using both cross-sectional and time-series methodologies, we find that innovations in implied idiosyncratic volatility explain future returns for a sample of 2864 optionable firms examined during the 1999–2010 sample period. We find that long-short portfolios formed using innovations in implied idiosyncratic volatility produce much larger abnormal returns than long-short portfolios formed using the level of implied idiosyncratic volatility. We also find that significant (both statistically and economically) abnormal returns continue to be generated for portfolios formed using innovations in implied idiosyncratic volatility when the sample is partitioned by: firm size, book-to-market equity, implied idiosyncratic volatility persistence, volatility risk, jump risk and option skewness. Our cross-sectional results lead to similar conclusions and are robust to the inclusion of traditional risk factors. Therefore, our results provide evidence of a significant and, to this point, undetected ex ante measure of risk.

Suggested Citation

  • Moll, Cliff R. & Huffman, Stephen P., 2016. "The incremental information content of innovations in implied idiosyncratic volatility," Review of Financial Economics, Elsevier, vol. 30(C), pages 33-44.
    • Handle: RePEc:eee:revfin:v:30:y:2016:i:c:p:33-44
    DOI: 10.1016/j.rfe.2016.04.001
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    More about this item

    Keywords

    Risk–return; Asset pricing; Derivatives; Options;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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