Volatility timing,sentiment, and the short-term profitability of VIX-based cross-sectional trading strategies |
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Institution: | 1. Department of Finance and Management Science, Carson College of Business, Washington State University, Pullman, WA, 99164, USA;2. School of Economics, Shanghai University of Finance and Economics, Shanghai 200433, China;3. School of Economics, Jinan University, Guangzhou 510632, China |
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Abstract: | This paper explores the profitability of simple short-term cross-sectional trading strategies based on the implied volatility index (VIX), often referred to as an “investor fear gauge” in the stock market. These strategies involve holding sentiment-prone stocks when VIX is low and sentiment-immune stocks when VIX is high and generate significantly higher excess returns than the benchmark long–short portfolios that do not condition on VIX. We show that the profitability of our trading strategies is not subsumed by the well-known risk factors or transaction cost adjustments. Our findings are consistent with the theory of delayed arbitrage and the synchronization problem of Abreu and Brunnermeier (2002). |
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Keywords: | Implied volatility Trading strategies Cross-sectional return Investor sentiment Delayed arbitrage |
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