Relationship Between Implied Volatility and Dividend Yield

Much has been discussed about the relationship between implied volatility (IV) and realized volatility, between IVs of different markets, asset classes, maturities, etc. However little has been discussed about the relationship between IV and dividend yield.

The dividend yield is a financial ratio that indicates how much a company pays out in dividends each year relative to its stock price. It is calculated by dividing the annual dividends per share by the current market price per share. Dividend yield provides investors with a measure of the income they can expect to earn from holding a stock, expressed as a percentage.

Reference [1] explored the relationship between IV and dividend yield. The authors pointed out,

The main regression on call option implied volatility revealed that dividend yield exhibited negative coefficients across all models, however, the results were statistically insignificant in half of the models. This suggests that changes in dividend yield have a consistent impact on call option implied volatility in half of the models, aligning more with the Bird-in-hand theory than the dividend irrelevancy theory. The regression on put option implied volatility showed negative and significant coefficients for dividend yield across most models, indicating a stronger and more consistent relationship compared to call options. This is in conjunction with the Bird-in-hand theory, suggesting that higher dividend yields lead to lower implied volatility in put options…

Overall, our findings support our hypothesis, indicating that a positive change in a firm's dividend yield tends to affect future volatility negatively. This effect was particularly significant in the put option models but also showed signs of significance in the call option models. The consistent negative coefficients for dividend yield across most models in both put and call option regressions suggest that higher dividend yields lead to lower implied volatility, thus endorsing the Bird-in-hand theory in options markets.

Essentially, there exists a negative relationship between dividend yield and IV, and this relationship is stronger for puts than calls. Overall, the study supports the bird-in-hand theory rather than the dividend irrelevance theory.

Let us know what you think in the comments below or in the discussion forum.

References

[1] Jonathan Nestenborg, Gustav Sjöberg, Option Implied Volatility and Dividend Yields, Linnaeus University, 2024

Originally Published Here: Relationship Between Implied Volatility and Dividend Yield

source https://harbourfronts.com/relationship-implied-volatility-dividend-yield/