Do investor sentiment, weather and catastrophe effects improve hedging performance? Evidence from the Taiwan options market

•We study investor sentiment, weather and catastrophe effects on hedging performance.•Put-call open interest ratio (PCO) has the best predictive ability of realized volatility.•Option volatility index (VIX), PCO and earthquakes can help predict volatility.•VIX, PCO and changes in cloud cover raise the hedging performance of Taiwan options.

This study examines the usefulness of incorporating investor sentiment, weather, and catastrophe effects into the benchmark volatility model for an effective hedging strategy in the Taiwan options market. The empirical results indicate that investor sentiment, as measured by the option volatility index (VIX) and put-call open interest ratio (PCO), and the catastrophic factors of earthquakes (EQ) can help explain realized volatility and that the PCO has the best predictive ability. Incorporating investor sentiment and weather effects improves the hedging performance of options. VIX and changes in cloud cover (ΔCC) have significant improvement level for hedging performance, the highest of which are 0.44% and 5.36%, respectively.