Do Fear Indices Help Predict Stock Returns?

34 Pages Posted: 1 Aug 2012

See all articles by Ghulame Rubbaniy

Ghulame Rubbaniy

Zayed University - College of Business; University of the West of England

Robel Asmerom

affiliation not provided to SSRN

Syed Kumail Abbas Rizvi

Université Paris 1 (Panthéon-Sorbonne); Lahore School of Economics

Date Written: August 1, 2012

Abstract

This study investigates the forecasting power of implied volatility indices on forward looking returns. Prior studies document that negative innovations to returns are associated with increasing implied volatility of the underlying indices; thus, suggesting a possible relationship between extremely high levels of implied volatility and positive short term returns. We investigate this issue by examining the predictive power of three implied volatility indices, VIX, VXN and VDAX, on the underlying index returns. We extend previous research by also focusing on individual stocks and examine the relationship between implied volatility indices and future returns across different sectors and classified portfolios. Our findings suggest that implied volatility indices are good predictors of 20-days and 60-days forward looking returns and illustrate insignificant predictive power for very short term (1-day and 5-days) returns.

Suggested Citation

Rubbaniy, Ghulame and Asmerom, Robel and Rizvi, Syed Kumail Abbas and Rizvi, Syed Kumail Abbas, Do Fear Indices Help Predict Stock Returns? (August 1, 2012). Available at SSRN: https://ssrn.com/abstract=2121274 or http://dx.doi.org/10.2139/ssrn.2121274

Ghulame Rubbaniy (Contact Author)

Zayed University - College of Business ( email )

Zayed University
P.O. Box 144534
Abu Dhabi
United Arab Emirates

University of the West of England ( email )

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United Kingdom
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Robel Asmerom

affiliation not provided to SSRN

Lahore School of Economics ( email )

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Pakistan