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Option Implied Volatility (option + implied_volatility)

Distribution by Scientific Domains

Business, Economics, Finance and Accounting	100%

Selected Abstracts

The economic significance of conditional skewness in index option markets

THE JOURNAL OF FUTURES MARKETS, Issue 4 2010
Ranjini Jha
This study examines whether conditional skewness forecasts of the underlying asset returns can be used to trade profitably in the index options market. The results indicate that a more general skewness-based option-pricing model can generate better trading performance for strip and strap trades. The results show that conditional skewness model forecasts, when combined with forward-looking option implied volatilities, can significantly improve the performance of skewness-based trades but trading costs considerably weaken the profitability of index option strategies. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:378,406, 2010 [source]

The drift factor in biased futures index pricing models: A new look

THE JOURNAL OF FUTURES MARKETS, Issue 6 2002
W. Brian Barrett
The presence of bias in index futures prices has been investigated in various research studies. Redfield (11) asserted that the U.S. Dollar Index (USDX) futures contract traded on the U.S. Cotton Exchange (now the FINEX division of the New York Board of Trade) could be systematically arbitraged for nontrivial returns because it is expressed in so-called "European terms" (foreign currency units/U.S. dollar). Eytan, Harpaz, and Krull (4) (EHK) developed a theoretical factor using Brownian motion to correct for the European terms and the bias due to the USDX index being expressed as a geometric average. Harpaz, Krull, and Yagil (5) empirically tested the EHK index. They used the historical volatility to proxy the EHK volatility specification. Since 1990, it has become more commonplace to use option-implied volatility for forecasting future volatility. Therefore, we have substituted option implied volatilities into EHK's correction factor and hypothesized that the correction factor is "better" ex ante and therefore should lead to better futures model pricing. We tested this conjecture using twelve contracts from 1995 through 1997 and found that the use of implied volatility did not improve the bias correction over the use of historical volatility. Furthermore, no matter which volatility specification we used, the model futures price appeared to be mis-specified. To investigate further, we added a simple naïve , based on a modification of the adaptive expectations model. Repeating the tests using this naïve "drift" factor, it performed substantially better than the other two specifications. Our conclusion is that there may be a need to take a new look at the drift-factor specification currently in use. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:579,598, 2002 [source]

A High-Frequency Investigation of the Interaction between Volatility and DAX Returns

EUROPEAN FINANCIAL MANAGEMENT, Issue 3 2010
Philippe Masset
G10; G12; G13 Abstract One of the most noticeable stylised facts in finance is that stock index returns are negatively correlated with changes in volatility. The economic rationale for the effect is still controversial. The competing explanations have different implications for the origin of the relationship: Are volatility changes induced by index movements, or inversely, does volatility drive index returns? To differentiate between the alternative hypotheses, we analyse the lead-lag relationship of option implied volatility and index return in Germany based on Granger causality tests and impulse-response functions. Our dataset consists of all transactions in DAX options and futures over the time period from 1995 to 2005. Analyzing returns over 5-minute intervals, we find that the relationship is return-driven in the sense that index returns Granger cause volatility changes. This causal relationship is statistically and economically significant and can be clearly separated from the contemporaneous correlation. The largest part of the implied volatility response occurs immediately, but we also observe a smaller retarded reaction for up to one hour. A volatility feedback effect is not discernible. If it exists, the stock market appears to correctly anticipate its importance for index returns. [source]

RISK PREMIUM EFFECTS ON IMPLIED VOLATILITY REGRESSIONS

THE JOURNAL OF FINANCIAL RESEARCH, Issue 2 2010
Leonidas S. Rompolis
Abstract This article provides new insights into the sources of bias of option implied volatility to forecast its physical counterpart. We argue that this bias can be attributed to volatility risk premium effects. The latter are found to depend on high-order cumulants of the risk-neutral density. These cumulants capture the risk-averse behavior of investors in the stock and option markets for bearing the investment risk that is reflected in the deviations of the implied risk-neutral distribution from the normal distribution. We show that the bias of implied volatility to forecast its corresponding physical measure can be eliminated when the implied volatility regressions are adjusted for risk premium effects. The latter are captured mainly by the third-order risk-neutral cumulant. We also show that a substantial reduction of higher order risk-neutral cumulants biases to predict their corresponding physical cumulants is supported when adjustments for risk premium effects are made. [source]

The information content of option implied volatility surrounding the 1997 Hong Kong stock market crash

THE JOURNAL OF FUTURES MARKETS, Issue 6 2007
Joseph K. W. Fung
This study examines the information conveyed by options and examines their implied volatility at the time of the 1997 Hong Kong stock market crash. The author determines the efficiency of implied volatility as a predictor of future volatility by comparing it to other leading indicator candidates. These include volume and open interest of index options and futures, as well as the arbitrage basis of index futures. Using monthly, nonoverlapping data, the study reveals that implied volatility is superior to those variables in forecasting future realized volatility. The study also demonstrates that a simple signal extraction model could have produced useful warning signals prior to periods of extreme volatility. These results indicate that the options market is highly efficient informationally. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:555,574, 2007 [source]