Implied Asset Volatility Factor
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Implied Asset Return Profiles, Firm Fundamentals, and Stock Returns
Jongsub Lee; Andy Naranjo; Stace Sirmans
- KRSeoul National University
- University of Florida
- ?University of Florida - Warrington College of Business Administration
- Auburn University
- ?Auburn University - Department of Finance
Strategy in a nutshell
Universe: NYSE, AMEX, Nasdaq stocks with market cap ≥ $100M, price ≥ $1, and 5-year CDS. Use Merton’s model to compute 6-month asset return and volatility changes. Stocks are double-sorted by return and volatility:
Short top volatility quintile within each return quintile.
Equally weighted, monthly rebalanced.
Long bottom volatility quintile,
Economic rationale
Asset volatility changes predict future returns: higher volatility changes (conditional on returns) signal lower future returns and higher idiosyncratic earnings volatility. This factor is persistent, tied to firm fundamentals, and not explained by common risk factors.
Backtest performance
Annualised return5.91%
Volatility4.86%
Sharpe ratio0.93