Idiosyncratic volatility, option-based measures of informed trading, and investor attention
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In: Review of Derivatives Research, Vol. 24, No. 3, 10.2021, p. 197-220.
Research output: Journal contributions › Journal articles › Research › peer-review
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TY - JOUR
T1 - Idiosyncratic volatility, option-based measures of informed trading, and investor attention
AU - Mohrschladt, Hannes
AU - Schneider, Judith C.
N1 - Open Access funding enabled and organized by Projekt DEAL. Financial support from the German Research Foundation (DFG grant number 316058991) is gratefully acknowledged.
PY - 2021/10
Y1 - 2021/10
N2 - We establish a direct link between sophisticated investors in the option market, private stock market investors, and the idiosyncratic volatility (IVol) puzzle. To do so, we employ three option-based volatility spreads and attention data from Google Trends. In line with the IVol puzzle, the volatility spreads indicate that sophisticated investors indeed consider high-IVol stocks as being overvalued. Moreover, the option measures help to distinguish overpriced from fairly priced high-IVol stocks. Thus, these measures are able to predict the IVol puzzle’s magnitude in the cross-section of stock returns. Further, we link the origin of the IVol puzzle to the trading activity of irrational private investors as the return predictability only exists among stocks that receive a high level of private investor attention. Overall, our joint examination of option and stock markets sheds light on the behavior of different investor groups and their contribution to the IVol puzzle. Thereby, our analyses support the intuitive idea that noise trading leads to mispricing, which is identified by sophisticated investors and exploited in the option market.
AB - We establish a direct link between sophisticated investors in the option market, private stock market investors, and the idiosyncratic volatility (IVol) puzzle. To do so, we employ three option-based volatility spreads and attention data from Google Trends. In line with the IVol puzzle, the volatility spreads indicate that sophisticated investors indeed consider high-IVol stocks as being overvalued. Moreover, the option measures help to distinguish overpriced from fairly priced high-IVol stocks. Thus, these measures are able to predict the IVol puzzle’s magnitude in the cross-section of stock returns. Further, we link the origin of the IVol puzzle to the trading activity of irrational private investors as the return predictability only exists among stocks that receive a high level of private investor attention. Overall, our joint examination of option and stock markets sheds light on the behavior of different investor groups and their contribution to the IVol puzzle. Thereby, our analyses support the intuitive idea that noise trading leads to mispricing, which is identified by sophisticated investors and exploited in the option market.
KW - Idiosyncratic volatility puzzle
KW - Investor attention
KW - Option-implied volatility spreads
KW - Management studies
UR - http://www.scopus.com/inward/record.url?scp=85099955465&partnerID=8YFLogxK
U2 - 10.1007/s11147-021-09175-7
DO - 10.1007/s11147-021-09175-7
M3 - Journal articles
AN - SCOPUS:85099955465
VL - 24
SP - 197
EP - 220
JO - Review of Derivatives Research
JF - Review of Derivatives Research
SN - 1380-6645
IS - 3
ER -