Stock Returns, Implied Volatility Innovations, and the Asymmetric Volatility Phenomenon

Abstract

We study the dynamic relation between daily stock returns and daily innovations in option-derived implied volatilities. By simultaneously analyzing innovations in index-level and firm-level implied volatilities, we distinguish between innovations in systematic and idiosyncratic volatility in an effort to better understand the asymmetric volatility phenomenon. Our results indicate that the relation between stock returns and innovations in systematic volatility (idiosyncratic volatility) is substantially negative (near zero). These results suggest that asymmetric volatility is primarily attributed to systematic market-wide factors, rather than aggregated firm-level effects. We also present evidence that supports our assumption that innovations in implied volatility are good proxies for innovations in expected stock volatility.

Keywords: Implied Volatility, Asymmetric Volatility Phenomenon

JEL Classification: G12, G14, D80