Implied Volatility Changes and Corporate Bond Returns

Abstract

Corporate bonds with large increases in implied volatility over the past month underperform those with large decreases in implied volatility by 0.6% per month. In contrast to existing studies that show implied volatility changes carry information about fundamental news, our evidence suggests that implied volatility changes contain information about uncertainty shocks to the firm. Our results are consistent with the notion that informed traders with new information about firm risk prefer to trade in the option market and the corporate bond market underreacts to this information. This paper was accepted by Haoxiang Zhu, finance. Funding: We thank the Canadian Derivatives Institute for financial support. J. Cao and X. Zhan acknowledge generous financial support of the Research Grant Council of the Hong Kong Special Administrative Region, China [Grants GRF 14501720, 14500919]. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4379 .