Firm-specific sentiment and individual option's implied volatility slope
ISSN: 1940-5979
Article publication date: 29 March 2022
Issue publication date: 21 August 2023
Abstract
Purpose
Previous literature shows that market sentiment and the steepness of index option's implied volatility slope have a negative relation. This paper investigates the relation between firm-specific sentiment and individual option's implied volatility slope both theoretically and empirically.
Design/methodology/approach
The authors develop a simple model with option traders' sentiment heterogeneity to show that sentiment and the steepness of individual option's implied volatility slope have a positive relation.
Findings
When firm-specific sentiment is higher (more bullish), individual option's implied volatility slope becomes steeper. The positive relation is stronger when option traders' beliefs on risk are more dispersed. Empirical results support the theoretical model predictions.
Originality/value
Although both firm-specific sentiment and individual options implied volatility slope predict future stock returns, there is no research exploring the relation between them. In particular, none of previous studies associates implied volatility slope's stock return predictability to investor behavior such as sentiment. The authors’ findings provide a behavior-based explanation on why steep implied volatility slope negatively predicts cross-sectional stock returns.
Keywords
Citation
Chen, B. and Gan, Q. (2023), "Firm-specific sentiment and individual option's implied volatility slope", Review of Behavioral Finance, Vol. 15 No. 5, pp. 672-693. https://doi.org/10.1108/RBF-10-2021-0216
Publisher
:Emerald Publishing Limited
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