A1161
Title: Long-run and short-run idiosyncratic stock volatilities and cross-section of option returns
Authors: Quan Gan - University of Sydney (Australia) [presenting]
Van Quoc Thinh Nguyen - University of Sydney (Australia)
Abstract: Stock idiosyncratic volatility is decomposed into long-run and short-run components, and both are negatively related to delta-hedged option returns. The effects of the long-run and short-run components are explained by the limits of arbitrage and stock return jumps, respectively. Unlike the long-run component, the short-run component can be used to create an option trading strategy that remains profitable after considering transaction costs. In economic downturns, only the short-run idiosyncratic volatility effect is significant. Further analysis shows that the limits-of-arbitrage's explaining power arises from its intercept and common component, while the jump's explaining power arises from its residual component relating to corporate news arrivals.
