Detecting stock market regimes from option prices |
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Institution: | Skema Business School, Université Cote d''Azur. 60 rue Fedor Dostoïevski, 06902 Valbonne, France |
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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. |
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Keywords: | Options Regime switching Equity risk premium |
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