Essays on information content of index options for stock market movements

Abstract

My dissertation aims at understanding the relationship between information of index options and stock market movements.The first essay examines whether risk-neutral skewness has incremental explanatory power for future volatility in the S&P 500 index. While most of previous studies have investigated the usefulness of historical volatility and implied volatility for volatility forecasting, we study the information content of risk-neutral skewness in volatility forecasting model. In particular, we concentrate on Heterogeneous Autoregressive model of Realized Volatility and Implied Volatility (HAR-RV-IV). We find that risk-neutral skewness contains additional information for future volatility, relative to past realized volatilities and implied volatility. Out-of-sample analyses confirm that risk-neutral skewness improves significantly the accuracy of volatility forecasts for future volatility.The second essay shows that the growth of option open interest has predictive power for stock market returns. Predictability is demonstrated through in-sample tests, as evidenced by significant p-values and the improvement of adjusted R^2 in monthly predictive regressions, and by out-of-sample metrics. In addition, stock return predictability confirms the economic significance of the growth of option open interest, as shown by improving Sharpe ratios of returns from a predictor variable-based decision rule that exploits the growth of option open interest. Our empirical evidence indicates that the growth of option open interest provides additional information for future stock market returns, relative to other popular predictor variables.The third essay investigates the predictability of dispersion in implied volatilities of future stock market returns derived from investors’ heterogeneity beliefs about the expected stock returns and expected stock return volatilities. We find that the dispersion in option implied volatilities across moneyness positively predicts future stock ...