Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?

This paper examines the relation between net buying pressure and the shape of the implied volatility function (IVF) for index and individual stock options. We find that changes in implied volatility are directly related to net buying pressure from public order flow. We also find that changes in implied volatility of S&P 500 options are most strongly affected by buying pressure for index puts, while changes in implied volatility of stock options are dominated by call option demand. Simulated delta‐neutral option‐writing trading strategies generate abnormal returns that match the deviations of the IVFs above realized historical return volatilities.     

Asymmetric Volatility and Trading Activity in Index Futures Options

We examine the impact of option trading activity on implied volatility changes to returns in the index futures option market. Controlling for option moneyness, delta‐to‐option‐premium ratio, and liquidity, we find that net buying pressure, profit‐maximization behavior, and liquidity are interrelated and affect asymmetric responses of implied volatilities to returns. Implied volatilities of options with more liquidity, a higher exercise price, and a higher delta‐to‐option‐premium ratio have the most profound asymmetric response.     

Business Cycles and Net Buying Pressure in the S&P 500 Futures Options

We analyse the cyclical behaviour and intraday pattern of net buying pressure in the S&P 500 futures options market. The results suggest that the net buying pressure of puts is counter‐cyclical and is more intense during contraction periods. The trading profits for selling put options during contraction periods thus far exceed those during expansion periods. Net buying pressure also exhibits an intraday pattern. Trading profits in the early trading sessions are higher than those for the rest of the day. In addition, we show that hourly‐basis hedging yields smaller profits than daily‐basis hedging, which suggests that the trading profits based on daily‐basis hedging may contain a risk premium associated with discretely rebalanced ‘risk‐free’ option portfolios.     

Investor sentiment and interest rate volatility smile: evidence from Eurodollar options markets

This paper studies the extent to which investor sentiment affects the Eurodollar option smile and finds that there is the dynamic interplay between sentiment-driven investors and arbitrageurs. The results reveal a significant relation between investor sentiment and interest rate volatility smile. The significant relations are stronger for put options, for short-maturity options, and for periods with higher uncertainty. The results are robust when considering controlling variables, net buying pressure, different interest rate option models, model-free method, or excluding rational components from the sentiment measures. Our findings favor the limits to arbitrage hypothesis against the positive feedback hypothesis, suggesting that the sentiment effect is transitory. Change in investor sentiment explains the time-varying smile that can be explained neither by rational interest rate models nor by net buying pressure.     

Effects of the volatility smile on exchange settlement practices: The Hong Kong case

The well-documented volatility smile phenomenon in the US options market has affected the option settlement practices of other markets. To settle Hang Seng Index (HSI) options, the Hong Kong Stock Exchange artificially builds in a piecewise linear “smile” or “sneer” volatility function, which is determined daily by market makers rather than directly by market forces. In this study, we investigate the time-varying settlement function and find the following economic determinants of the volatility function: lag parameters, current-day HSI returns, the distribution of HSI returns, transaction costs as proxied by the bid-ask spread, and the “Monday effect”. For evaluation purposes, we use as a benchmark the estimated piecewise linear volatility function as directly driven by market forces. The comparison analyses show that base volatilities set by market makers run somewhat high, while downside slopes are not steep enough. This results in the overpricing of the lion’s share of traded options. An economic determinants analysis of market-force-driven parameters reveals that market makers can better align artificial volatility parameters both by reducing reliance on the function parameters of prior days and by more precisely accounting for current-day HSI returns, option time-to-maturity, bid-ask spreads and buying pressure.     

Price discovery in the U.S. stock and stock options markets: A portfolio approach

Option prices vary with not only the underlying asset price, but also volatilities and higher moments. In this paper, we use a portfolio of options to seclude the value change of the portfolio from the impact of volatility and higher moments. We apply this portfolio approach to the price discovery analysis in the U.S. stock and stock options markets. We find that the price discovery on the directional movement of the stock price mainly occurs in the stock market, more so now than before as an increasing proportion of options market makers adopt automated quoting algorithms. Nevertheless, the options market becomes more informative during periods of significant options trading activities. The informativeness of the options quotes increases further when the options trading activity generates net sell or buy pressure on the underlying stock price, even more so when the pressure is consistent with deviations between the stock and the options market quotes. JEL Classification C52, G10, G13, G14     

Smile and default: the role of stochastic volatility and interest rates in counterparty credit risk

In this research, we investigate the impact of stochastic volatility and interest rates on counterparty credit risk (CCR) for FX derivatives. To achieve this we analyse two real-life cases in which the market conditions are different, namely during the 2008 credit crisis where risks are high and a period after the crisis in 2014, where volatility levels are low. The Heston model is extended by adding two Hull–White components which are calibrated to fit the EURUSD volatility surfaces. We then present future exposure profiles and credit value adjustments (CVAs) for plain vanilla cross-currency swaps (CCYS), barrier and American options and compare the different results when Heston-Hull–White-Hull–White or Black–Scholes dynamics are assumed. It is observed that the stochastic volatility has a significant impact on all the derivatives. For CCYS, some of the impact can be reduced by allowing for time-dependent variance. We further confirmed that Barrier options exposure and CVA is highly sensitive to volatility dynamics and that American options’ risk dynamics are significantly affected by the uncertainty in the interest rates.     

机构持股对股价微观波动影响的非对称性

文章利用topview机构投资者日持股数据,构建股价波动率与机构投资者日净买率等指标,使用GMM回归、滚动回归、递归回归,从个股角度动态分析机构投资者对股价微观波动的影响。实证结果表明,机构投资者对股价微观波动的影响因不同的市场状态而具有非对称性,并可以用信息假说进行解释。管理层应依据不同的市场状态而采取合适的措施以实现机构投资者的稳定作用。     

Dual long-memory, structural breaks and the link between turnover and the range-based volatility

This paper investigates the issue of temporal ordering of the range-based volatility and turnover volume in the Korean market for the period 1995–2005. We examine the dynamics of the two variables and their respective uncertainties using a bivariate dual long-memory model. We distinguish volume trading before the Asia financial crisis from trading after the crisis. We find that the apparent long-memory in the variables is quite resistant to the presence of breaks. However, when we take into account structural breaks the order of integration of the conditional variance series decreases considerably. Moreover, the impact of foreign volume on volatility is negative in the pre-crisis period but turns to positive after the crisis. This result is consistent with the view that foreign purchases tend to lower volatility in emerging markets—especially in the first few years after market liberalization when foreigners are buying into local markets—whereas foreign sales increase volatility. Before the crisis there is no causal effect for domestic volume on volatility whereas in the post-crisis period total and domestic volumes affect volatility positively. The former result is in line with the theoretical underpinnings that predict that trading within domestic investor groups does not affect volatility. The latter result is consistent with the theoretical argument that the positive relation between the two variables is driven by the uninformed general public.     

Do U.S. Insurance Firms Offer the “Wrong” Incentives to Their Executives?

We examine the relation between executive compensation and market‐implied default risk for listed insurance firms from 1992 to 2007. Shareholders are expected to encourage managerial risk sharing through equity‐based incentive compensation. We find that long‐term incentives and other share‐based plans do not affect the default risk faced by firms. However, the extensive use of stock options leads to higher future default risk for insurance firms. We argue that this is because option‐based incentives induce managerial risk‐taking behavior, which seeks to maximize managerial payoff through equity volatility. This could be detrimental to the interests of shareholders, especially during a financial crisis.     

VOLATILITY FORECASTS,TRADING VOLUME,AND THE ARCH VERSUS OPTION‐IMPLIED VOLATILITY TRADE‐OFF

We investigate empirically the role of trading volume (1) in predicting the relative informativeness of volatility forecasts produced by autoregressive conditional heteroskedasticity (ARCH) models versus the volatility forecasts derived from option prices, and (2) in improving volatility forecasts produced by ARCH and option models and combinations of models. Daily and monthly data are explored. We find that if trading volume was low during period t?1 relative to the recent past, ARCH is at least as important as options for forecasting future stock market volatility. Conversely, if volume was high during period t?1 relative to the recent past, option‐implied volatility is much more important than ARCH for forecasting future volatility. Considering relative trading volume as a proxy for changes in the set of information available to investors, our findings reveal an important switching role for trading volume between a volatility forecast that reflects relatively stale information (the historical ARCH estimate) and the option‐implied forward‐looking estimate.     

ON THE ROBUSTNESS OF RANGE‐BASED VOLATILITY ESTIMATORS

We empirically examine Parkinson's range‐based volatility estimate in the federal funds market, which is unique because institutional regulations create a predictable pattern in interday volatility. We find that range‐based volatility estimates and standard deviations produce the expected volatility pattern. We also find that at trading pressure points where microstructure noise should be greatest, range‐based estimates are less than the standard deviations. Thus, we support the argument that range‐based volatility estimates remove the upward bias created by microstructure noise. We find that the Parkinson method is the most efficient range‐based volatility measure among a set of alternates in this market.     

Stock Volatility during the Recent Financial Crisis

This paper uses monthly returns from 1802 to 2010, daily returns from 1885 to 2010, and intraday returns from 1982 to 2010 in the USA to show how stock volatility has changed over time. It also uses various measures of volatility implied by option prices to infer what the market was expecting to happen in the months following the financial crisis in late 2008. This episode was associated with historically high levels of stock market volatility, particularly among financial sector stocks, but the market did not expect volatility to remain high for long and it did not. This is in sharp contrast to the prolonged periods of high volatility during the Great Depression. Similar analysis of stock volatility in the United Kingdom and Japan reinforces the notion that the volatility seen in the 2008 crisis was relatively short‐lived. While there is a link between stock volatility and real economic activity, such as unemployment rates, it can be misleading.     

Sovereign CDS Spreads,Volatility, and Liquidity: Evidence from 2010 German Short Sale Ban

The paper examines global impact of 2010 German short sale ban on sovereign credit default swap (CDS) spreads, volatility, and liquidity across 54 countries. We find that CDS spreads continue rising after the ban in the debt crisis region, which suggests that the short selling ban is incapable of suppressing soaring borrowing costs in these countries. However, we find that the ban helps stabilize the CDS market by reducing CDS volatility. The reduction in CDS volatility is greater in the eurozone than that in the non‐eurozone. Furthermore, we find that the CDS market liquidity has been impaired during the ban for the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) countries. In contrast, there are no dramatic changes in the market liquidity for non‐PIIGS eurozone and non‐eurozone samples. The findings suggest that the short sale ban is ineffective to reduce sovereign borrowing costs in the debt crisis region if the underlying economy has not been significantly improved.     

Real Options,Volatility, and Stock Returns

We provide evidence that the positive relation between firm‐level stock returns and firm‐level return volatility is due to firms’ real options. Consistent with real option theory, we find that the positive volatility‐return relation is much stronger for firms with more real options and that the sensitivity of firm value to changes in volatility declines significantly after firms exercise their real options. We reconcile the evidence at the aggregate and firm levels by showing that the negative relation at the aggregate level may be due to aggregate market conditions that simultaneously affect both market returns and return volatility.     

Dynamic volatility spillovers across oil and natural gas futures markets based on a time-varying spillover method

This paper analyzes dynamic volatility spillovers between four major energy commodities (i.e., crude oil, gasoline, heating oil and natural gas) in the oil-natural gas future markets. We construct a time-varying spillover method by combining the TVP-VAR-SV model and the spillover method of Diebold and Yilmaz (2009, 2012, 2014). We use the spillover method to obtain time-varying total, directional and pairwise volatility spillover indices. Our results summarize as follows: (1) The volatility spillover indices present peaks and troughs during some periods, such as shale gas revolution, financial crisis, and oil price crash; (2) After the U.S. shale gas revolution, the size of volatility spillover from natural gas future market has reduced sharply, but volatility doesn't decouple from the other three oil future markets; (3) The directional spillover is asymmetric. The crude oil and heating oil futures market are main net transmitter of volatility risk information, while the gasoline and natural gas futures markets are the net receiver; (4) For natural gas future market, the pairwise volatility spillover from crude oil future market has the most significant influence.     

Cross‐Border Auction Cycle Effects of Sovereign Bond Issuance in the Euro Area

We provide evidence for the euro area of spillovers from foreign public debt auctions into domestic secondary‐market auction cycles. We also confirm existing evidence of such spillovers from domestic issues into the domestic secondary market. Consistent with a theory of primary dealers’ limited risk‐bearing capacity, we find that auction cycles from domestic issues are stronger during the recent crisis period, whereas cross‐border effects are stronger in the precrisis period, but this evidence is not strong. This finding likely reflects the opposing effects of reduced sovereign bond market integration during the crisis and higher yield covariances caused by more market volatility.     

Trading and Investing in Volatility Products

Since the banking crisis the market for volatility exchange‐traded products has developed rapidly as it opens to clients beyond the large institutional investor pool. Speculation is driven by increasingly complex leveraged and inverse exposures including those that attempt to trade on significant roll costs in volatility futures curves. Longer‐term investors use these products for the purposes of equity diversification, driven by fears of an ongoing Eurozone crisis. We survey the burgeoning academic literature in this area and present a comprehensive and up‐to‐date comparison of the market and statistical characteristics of European and US exchange‐traded volatility products.     

Funding liquidity and equity liquidity in the subprime crisis period: Evidence from the ETF market

Using index and financial exchange-traded funds (ETFs), this study explores the relation between funding liquidity and equity liquidity during the subprime crisis period. Our empirical results show that a higher degree of funding illiquidity leads to an increase in bid–ask spread and a reduction in both market depth and net buying imbalance. Such findings indicate that an increase in funding liquidity can improve equity liquidity, with a stronger effect for the financial ETFs than for the index ETFs. Our study provides a better overall understanding of the effect of the liquidity–supplier funding constraint during the subprime crisis period.     

Dynamic volatility spillovers and investment strategies between the Chinese stock market and commodity markets

Building on the increased interest in the volatility spillover effects between Chinese stock market and commodity markets, this paper investigates the dynamic volatility spillovers of Chinese stock market and Chinese commodity markets based on the volatility spillover index under the framework of TVP-VAR. The result shows that there is a highly dependent relationship between the stock market and commodity markets. On average, the Chinese stock market is the net recipient of spillover, non-ferrous metals and chemical industry have a very obvious spillover impact on the stock market. The degree of total volatility spillover is different in different periods. After major crisis events, the volatility correlation between markets increases. Since the outbreak of COVID-19, the spillover effect of the stock market on the commodity market has been significantly enhanced. Then optimal portfolio weights and hedge ratios are calculated for portfolio diversification and risk management. The result shows that the ability of most commodities to hedge against risks is significantly reduced when the crisis occurs; NMFI (precious metals) and CRFI (grain) still have good hedging ability after the crisis, but the effectiveness of hedging risk is relatively low. Besides, the combination of CRFI and SHCI (the Shanghai composite index) is the most effective for risk reduction.