Implied volatility and the risk-free rate of return in options markets |
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| Institution: | 1. University of California, Los Angeles (UCLA) Anderson School of Management, United States;2. National Bureau of Economic Research (NBER), United States;3. Leibniz Institute for Financial Research, Germany;4. London Business School, United Kingdom;5. Centre for Economic Policy Research (CEPR), United Kingdom;1. Risk Center, ETH Zürich, Scheuchzerstrasse 7, CH 8092 Zurich, Switzerland;2. Computational Social Science, ETH Zürich, Clausiusstrasse 37, CH 8092 Zurich, Switzerland |
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| Abstract: | We numerically solve systems of Black–Scholes formulas for implied volatility and implied risk-free rate of return. After using a seemingly unrelated regressions (SUR) model to obtain point estimates for implied volatility and implied risk-free rate, the options are re-priced using these parameters. After repricing, the difference between the market price and model price is increasing in time to expiration, while the effect of moneyness and the bid-ask spread are ambiguous. Our varying risk-free rate model yields Black–Scholes prices closer to market prices than the fixed risk-free rate model. In addition, our model is better for predicting future evolutions in model-free implied volatility as measured by the VIX. |
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| Keywords: | Re-pricing options Forecasting volatility Seemingly unrelated regression Implied volatility |
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