Publication
Detecting stock market regimes from option prices
Options
Regime switching
Equity risk premium
2022
2022, Operations Research Letters, 50(3), pp.260-267
Abstract
Equity market returns alternate between periods of calm and crises. Researchers commonly employ regime switching models to capture this behaviour. We show that forward-looking information extracted from option prices improves regime detection. In particular, horizon spreads in option-implied equity risk premia allow earlier detection of regime switches and improve prediction of the equity premium. This findings holds across recent disaster periods like the 2008/2009 financial crisis and the 2020 Covid pandemic outbreak, in both US and Emerging equity markets.