Correspondence: Michael Verhofen, Allianz Global Investors, Mainzer Landstrasse 11–13, 60329 Frankfurt, Germany. E-mail: michael.verhofen@allianzgi.de

¹is Professor of Finance at the University of St Gallen, Switzerland.

²is Portfolio Manager at Allianz Global Investors, and Lecturer in Finance at the University of St Gallen, Switzerland.

³is Research Assistant at the University of St Gallen, Switzerland.

Received 30 April 2008; Revised 30 April 2008.

Abstract

Using a complete sample of US equity options, we find a positive, highly significant relationship between stock returns and lagged implied volatilities. The results are robust after controlling for a number of factors such as firm size, market valuation, analyst recommendations and different levels of implied volatility. Lagged historical volatility is – in contrast to the corresponding implied volatility – not relevant for stock returns. We find considerable time variation in the relationship between lagged implied volatility and stock returns.