The option implied volatility of an asset can be explained by the market implied volatility. This simple model explains much of individual stocks’ expected volatility behavior. Through Monte Carlo simulation I show that standardized residuals from this model can be used to detect shocks to implied volatility.

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Standardized abnormal volatility captures an individual stock’s implied volatility which is not explained by its estimated relationship with the level of the VIX Index. I have shown by simulation that this measure can detect shocks to volatility. While shocks may be temporary or indicate lasting shifts in a stock’s risk structure, they may predict future stock portfolio returns.

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