What is the expected return on the stock market?Eevidence from korean options data

Abstract

We estimate the lower bound of the expected return of KOSPI200 from a volatility index, SVKOSPI. The square of SVKOSPI indicates the risk-neutral variance, it can be calculated from KOSPI200 index options with various maturities and strike prices. From 2003 to 2022, the lower bound of the expected excess return on KOSPI200 derived from the SVKOSPI index is 5% on average, which predicts the return on KOSPI200. The investment strategy using this predictive power shows a 148 percent point higher return than the KOSPI 200 index. In addition, the SVKOSPI index provides the advantage of analyzing the term structure of the expected return because it utilizes option data with various maturities. We are able to identify different patterns of the term structure compared to other periods during the 2008 financial crisis or COVID-19. SVKOSPI is meaningful as another volatility index because it does not require assumptions about the probability process of the underlying asset compared to VKOSPI, and it is easy to be hedged against the jumps of the underlying asset.