Corridor Volatility Risk and Expected Returns

<jats:sec><jats:label /><jats:p>This paper examines the pricing of volatility risk using SPX corridor implied volatility. We decompose model‐free implied volatility into various components using different segments of the cross‐section of out‐of‐the money put and call option prices. We find that only model‐free volatility computed from the cross‐section of out‐of‐the‐money call option prices carries a significant negative risk premium in the cross‐section of stock returns and subsumes all relevant information for forecasting future volatility. Our empirical results provide strong evidence that SPX out‐of‐the money put option prices do not contain useful information for pricing aggregate volatility risk in the cross‐section of stock returns. © 2015 Wiley Periodicals, Inc. Jrl Fut Mark 36:488–505, 2016</jats:p></jats:sec>