Which implied volatility provides the best measure of future volatility?

The volatility smile/skew phenomenon makes it unclear which implied volatility provides the best measure of the market volatility expectation over the remaining life of the option. Due to the high liquidity of at-the-money option and the low sensitivity of its implied volatility to the price error, the at-the-money implied volatility is often considered a good measure of future volatility. In this paper, we raise the question: is at-the-money implied volatility the best we can do? We provide in this paper an analytical rationale that the implied volatility from option with highest vega outperforms the at-the-money implied volatility in terms of forecasting ability, especially for long forecasting horizons. Our empirical findings are consistent with our theoretical argument.     

Arbitrage pricing theory and risk-neutral measures

Abstract We consider a market with countably many risky assets and finite factor structure, as in the “arbitrage pricing theory” of Ross (1976). We prove necessary and sufficient conditions in terms of parameters for the existence of an equivalent risk-neutral measure, i.e., a measure under which each asset return has zero expected value. We relate these conditions to a certain absence of arbitrage property of the model. Mathematics Subject Classification (2000): 91B24, 91B28 Journal of Economic Literature Classification: G10, G12     

Odds-setting efficiency in gambling markets: Evidence from the PGA TOUR

This paper describes the gambling market for PGA TOUR events for the 2002 season. The extent to which the odds predict the outcome is examined, illustrating how much information is captured in the odds and whether there are any identifiable biases in the odds. The overall implied profit to the casino is calculated as well as the returns to several naive betting strategies. By splitting the sample based on whether or not Tiger Woods is in the tournament, a “Tiger Woods effect” or a “thin market versus thick market effect” can be examined. On the whole, efficient markets propositions hold up, but the overwhelming share of the variation in the tournament outcome remains unexplained.     

Implementing efficient market structure

Abstract. This article studies the design of optimal mechanisms to regulate entry in natural oligopoly markets, assuming the regulator is unable to control the behavior of firms once they are in the market. We adapt the Clarke–Groves mechanism, characterize the optimal mechanism that maximizes the weighted sum of expected social surplus and expected tax revenue, and show that these mechanisms avoid budget deficits and prevent excessive entry. Received: 7 May 2001 / Accepted: 24 June 2002 We would like to thank seminar participants at Bonn and Berlin, in particular Peter Bank, Wieland Müller, and Urs Schweizer, the two anonymous referees, and the associate editor for most useful and exceptionally detailed comments. Financial support was received by the Deutsche Forschungsgemeinschaft, SFB 373 (“Quantifikation und Simulation ?konomischer Prozesse”), Humboldt–Universit?t zu Berlin.     

Interest rate dynamics and volatility transmission in the European short term interest rate market

This paper investigates the price and volatility relationship in European short-term interest rate markets. Cointegration analysis is used to analyse the long and short run relationship and a GARCH BEKK model is estimated to analyse the volatility transmission between the markets. The stability of the long run relationship is also examined using Bai and Perron (Econometrica 66(1),47–78, 1998, J Appl Econ 18(1):1–22, 2003) structural break methodology. The results show that the relationship between the EURIBOR spot deposit rate and the EURIBOR future contract has changed significantly since 2001 and several structural breaks are present in the 13 year sample period. During periods where there is a long run relationship present the spot deposit rate generally leads the future rate in price discovery. In the short run there is bi-directional causality present between the markets. There is also significant evidence of volatility transmission from the spot market to the futures market throughout the sample period.     

The dynamic impact of oil price shocks on the stock market and the USD/RMB exchange rate: Evidence from implied volatility indices

Using daily data from March 16, 2011, to September 9, 2019, we explore the dynamic impact of the oil implied volatility index (OVX) changes on the Chinese stock implied volatility index (VXFXI) changes and on the USD/RMB exchange rate implied volatility index (USDCNYV1M) changes. Through a TVP-VAR model, we analyse the time-varying uncertainty transmission effects across the three markets, measured by the changes in implied volatility indices. The empirical results show that the OVX changes are the dominant factor, which has a positive impact on the USDCNYV1M changes and the VXFXI changes during periods of important political and economic events. Moreover, USDCNYV1M changes are the key factor affecting the impact of OVX changes on VXFXI changes. When the oil crisis, exchange rate reform, and stock market crash occurred during 2014–2016, the positive effects of uncertainty transmission among the oil market, the Chinese stock market, and the bilateral exchange rate are significantly strengthened. Finally, we find that the positive effects are significant in the short term but diminish over time.     

IPO mechanism selection by using Classification and Regression Trees

The Turkish IPO market gives issuers and underwriters a choice of three different IPO selling mechanisms. The current paper sheds new light on the determinants of these issue procedures within the context of the following methods (i) book building mechanism, (ii) fixed price offer, and (iii) sale through the stock exchange. Most of the empirical models in the IPO literature use binary probit and logit models to determine the factors behind the choice of one method over another and try to answer the question of “why is such a mechanism chosen”. To understand the reasons on issuers’ selection of IPO mechanism, we have conducted a Classification and Regression Trees (CART) methodology to represent decision rules in a form of binary trees. Our results indicate that, CART methodology predicts a firms’ IPO selling mechanism with 77.42% accuracy. The most important variable that determines the IPO selling mechanism is the Arrangement Type between the issuer and the underwriter as in the form of best effort and firm-commitment.     

Expected market returns: SVIX,realized volatility,and the role of dividends

This note provides a replication of Martin's (Quarterly Journal of Economics, 2017, 132(1), 367–433) finding that the implied volatility measure SVIX predicts US stock market returns up to 12‐month horizons. I find that this result holds for both S&P 500 and CRSP market returns, regardless of whether returns include or exclude dividends. The predictability largely disappears after the SVIX index is replaced by an exponentially weighted moving average measure of realized volatility, suggesting that SVIX holds incremental forward‐looking information compared to realized volatility, despite the high correlation between the two volatility measures.     

Verbesserung des nicht-randomisierten exakten Testes von R.A. Fisher

Summary The so-called Exact Test of R. A. Fisher for comparing two probabilitiesp ₁ andp ₂ in a Fourfold-Table with small cell frequencies is known as a UMPU-Test. But in practice the test is used in a nonrandomized, often tabulated version. Given a certain level of significanceα it is shown: the critical region of this nonrandomized test, referred to as “Fisher 1”, can be enlarged considerably. For instance for all sample-size-sums up to 20 andα=0.01 the total number of points in the critical regions of “Fisher 1” is 552 whereas the analogous number of the new version “Fisher 2” is 788. The size of tables for “Fisher 2” can be reduced considerably because the main parts of the critical regions can be described by the aid of some Chi-square-test versions. In particular Yates’ continuity-correction turns out to be always conservative in the above mentioned region relative to “Fisher 2” whereas this is not strictly true relative to “Fisher 1”.      

Implied volatility term structure and exchange rate predictability

This paper provides empirical evidence of the predictive power of the currency implied volatility term structure (IVTS) for the behavior of the exchange rate from both cross-sectional and time series perspectives. Intriguingly, the direction of the prediction is not the same for developed and emerging markets. For developed markets, a high slope means low future returns, while for emerging markets it means high future returns. We analyze predictability from a cross-sectional perspective by building portfolios based on the slope of the term structure, and thus present a new currency trading strategy. For developed (emerging) currencies, we buy (sell) the two currencies with the lowest slopes and sell (buy) the two with the highest slopes. The proposed strategy performs better than common currency strategies – carry trade, risk reversal, and volatility risk premium (VRP) – based on the Sharpe ratio, considering only currency returns, which supports the exchange rate predictability of the IVTS from a cross-sectional perspective.     

Stock Prices and the Real Economy: Power Law versus Exponential Distributions

This paper explores the relationship between the stock prices and the real economy. The standard approach – the so called consumption-based asset pricing model – attempts to explain it based on the assumption of the representative agent. In this paper, we argue that the representative agent assumption is fundamentally flawed. Drawing on the recent advancement of “econophysics” on financial markets See Mantegna and Stanley (An Introduction to econophysics: correlations and complexity in finance, 2000) for the introduction to econophysics, we argue that in contrast to the neoclassical view, there is in fact a wedge between financial markets, the stock prices in particular, and the real economy.     

Regional information and market efficiency: the case of spread betting in United States college football

Using game results over a seven year span (1999–2006), we find that United States college football teams in arid regions “win” against the spread in 56.64% of games in which they host a team from a humid region. This result provides statistically significant evidence for both weak and strong form inefficiency in the spread betting markets of such games. By examining other cases of intraregional and interregional competition within the sport, we conclude that this inefficiency does not arise from the effects of travel or home field advantage. Rather, the result indicates that climate aridity is an observed characteristic for which college football betting markets do not accurately control. It is quite rare to find strong form market inefficiency arise from a single variable rather than from an elaborate, multivariable betting strategy. Therefore, the effect of climate aridity upon college football spread betting market efficiency can be characterized as dramatic. It is conjectured that remote market participants may need to “experience” certain types of relevant regional information, such as climate, to act in a market efficient manner.     

Threshold Modelling of Stock Return Volatility on Eastern European Markets.

A common finding for developed stock markets is that negative shocks entering the market lead to a larger return volatility than positive shocks of a similar magnitude. The following paper considers two emerging Eastern European Markets where the first point of investigation is whether an analogous asymmetric characteristic is reflected in emerging markets. The second point of investigation is whether the findings differ depending on the institutional microstructure of the exchange being examined. Hence, econometric techniques are adjusted and a ‘double-censored tobit GARCH’ model is developed. This paper finds that no asymmetry exists on either markets and possible reasons for this are proposed. JEL Classification: G14, G15, P21, P34. This revised version was published online in July 2006 with corrections to the Cover Date.     

Stock market volatility,the news,and monetary policy

The dynamic relationship linking the volatility of equity prices with “the news” and the expected path for monetary policy is investigated. Previous results that link the impact of the news about real activity to changes in current and future interest rates are employed in developing a positive link between changes in volatility and the news. Empirically, our results uncover a positive and statistically significant response of the CBOE volatility index, VIX, to unanticipated changes in employment, but not to inflation. Hence, agents' expectations for the policy response to news have an important influence on the expected volatility of stock prices. (JEL E44, E52)     

Testing the stabilization hypothesis in the UK short-term interest rates: Evidence from a GARCH-X model

The objective of this paper is to examine the validity of one of the recurring arguments made against futures markets that they give rise to price instability. The paper concentrates on the impact of futures trading on the spot market volatility of short-term interest rates. The analytical framework employed is based on a new statistical approach aiming to reconcile the traditional models of short-term interest rates and the conditional volatility processes. More specifically, this class of models aims to capture the dynamics of short-term interest rate volatility by allowing volatility to depend on both scale effects and information shocks. Using a GARCH-X and asymmetric GARCH-X model four main conclusions emerge from the present study. First, the empirical results suggest that there is an indisputable change in the nature of volatility with evidence of mean reversion after the onset of futures trading. Second, the information flow into the market has improved as a result of futures trading. Third, a stabilization effect has been detected running from the futures market to the cash market by lowering volatility levels and decreasing the risk in the spot market. Finally, trying to capture the leverage effect the findings suggest that positive shocks have a greater impact on volatility than negative shocks.     

Taxes and money in incomplete financial markets

Abstract We analyze a model with incomplete financial markets, where money is needed to pay taxes. Equilibria exist, are typically regular and not Pareto optimal. Moreover, generically, there exists a redistribution of money among households which leads to a Pareto superior equilibrium. The intervention occurs only in the first period and it does not require either closing markets or upper bounds on the number of households. Mathematics Subject Classification (2000): 91B50 Journal of Economic Literature Classification: D52, D60, E50, H20     

Implied volatility surfaces and market activity over time

An impressive body of the literature has investigated the patterns of changes in implied volatilities across strike prices and maturities. Although such studies try to explain the existence of the volatility skew and term structure, they remain silent about the evolution of the volatility surface as time goes by and market variables move. Relying on a technique of signal processing called Independent Component Analysis, we extract volatility modes that account for most of the variations in the shape of the surface. We then relate the magnitude of volatility changes along those modes to market activity.     

The role of implied volatility in forecasting future realized volatility and jumps in foreign exchange,stock, and bond markets

We study the forecasting of future realized volatility in the foreign exchange, stock, and bond markets from variables in our information set, including implied volatility backed out from option prices. Realized volatility is separated into its continuous and jump components, and the heterogeneous autoregressive (HAR) model is applied with implied volatility as an additional forecasting variable. A vector HAR (VecHAR) model for the resulting simultaneous system is introduced, controlling for possible endogeneity issues. We find that implied volatility contains incremental information about future volatility in all three markets, relative to past continuous and jump components, and it is an unbiased forecast in the foreign exchange and stock markets. Out-of-sample forecasting experiments confirm that implied volatility is important in forecasting future realized volatility components in all three markets. Perhaps surprisingly, the jump component is, to some extent, predictable, and options appear calibrated to incorporate information about future jumps in all three markets.     

Market and learning orientation in times of turbulence: relevance questioned? An analysis using a multi-case study

This paper aims to pinpoint and to discuss the factors that determine (i) why companies which have previously not been market oriented become so, and (ii) why already market-oriented companies increase their level of market orientation. This paper also analyses drivers of market orientation adoption and dynamics of processes as well as potential links between market orientation, strategy and learning orientation. Empirical research is based on a multi-case study of the Spanish construction and real state industry, providing a longitudinal approach. Data suggest that competitive environments trigger heightened interest in the market orientation and learning orientation constructs. In the analysed industry market orientation seems to be more prevalent in the “sunset” rather than before during the “sunrise” of the industry, which is opposite to the early work of Baker et al. (In: Sauders J (ed) The Marketing Initiative: ESRC Studies into British Marketing. Preentice-Hall, Hemel Hempstead, 1994). The link between market orientation and strategy is unclear, but proactive firms are better prepared for periods of crisis. Thinking on practical implications, this research highlights the relevance of market orientation and learning orientation in times of turbulence and suggests that proactive firms are better prepared for times of turbulence. The paper also includes discussion and implications for both literature and practice. Recommendations for best practices are also provided.     

The impact of VIX on China’s financial market: A new perspective based on high-dimensional and time-varying methods

Based on the new perspective of high-dimensional and time-varying methods, this paper analyzes the contagion effects of US financial market volatility on China’s nine financial sub-markets. The results show evidence of non-linear Granger causality from the US financial volatility (VIX) to the China’s financial markets. Increased US financial volatility has a negative next-day impact on the stock, bond, fund, interest rate, foreign exchange, industrial product and agricultural product markets, and a positive next-day impact on the gold and real estate markets. US financial volatility has the greatest impact on industrial product market, following by stock, agricultural product, fund, real estate, bond, gold, foreign exchange, and interest rates. Major risk events such as the global financial crisis can cause an enhanced contagion effect of US financial volatility to China's financial markets. This paper supports the achievements of China's actions to prevent and resolve major financial risks in the period of the COVID-19 epidemic.