Volatility Uncertainty and the Cross-Section of Option Returns PDF Download

Author: Jie Cao
Publisher:
ISBN:
Category :
Languages : en
Pages : 53

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Book Description
This paper studies the relation between the uncertainty of volatility, measured as the volatility of volatility, and future delta-hedged equity option returns. We find that delta-hedged option returns consistently decrease in uncertainty of volatility. Our results hold for different measures of volatility such as implied volatility, EGARCH volatility from daily returns, and realized volatility from high-frequency data. The results are robust to firm characteristics, stock and option liquidity, volatility characteristics, and jump risks, and are not explained by common risk factors. Our findings suggest that option dealers charge a higher premium for single-name options with high uncertainty of volatility, because these stock options are more difficult to hedge.

Author: Xinfeng Ruan
Publisher:
ISBN:
Category :
Languages : en
Pages : 93

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Book Description
This paper presents a robust new finding that there is a significantly negative relation between the equity option returns and the forward-looking volatility-of-volatility (VOV). After controlling for numerous existing option and stock characteristics, the VOV effect remains significantly negative. It also survives many robustness checks. A conceptual model provided in this paper reveals the pricing mechanism behind the VOV effect, i.e., the negative relation is due to the negative market price of the VOV risk. As investors dislike the VOV risk, they are willing to pay a high premium to hold options on high VOV stocks. The high-low return spread on option portfolios sorted on VOV cannot be explained by standard risk factors, and survives the double sorting on a variety of control variables. This confirms that the VOV effect is economically and statistically significant.

Author: Jie Cao
Publisher:
ISBN:
Category :
Languages : en
Pages : 48

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Book Description
This paper documents a robust new finding that delta-hedged equity option return decreases monotonically with an increase in the idiosyncratic volatility of the underlying stock. This result can not be explained by standard risk factors. It is distinct from existing anomalies in the stock market or volatility-related option mispricing. It is consistent with market imperfections and constrained financial intermediaries. Dealers charge a higher premium for options on high idiosyncratic volatility stocks due to their higher arbitrage costs. Controlling for limits to arbitrage proxies reduces the strength of the negative relation between delta-hedged option return and idiosyncratic volatility by about 40%.

Author: Guanglian Hu
Publisher:
ISBN:
Category :
Languages : en
Pages : 19

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Book Description
We analyze the relation between expected option returns and the volatility of the underlying securities. The expected return from holding a call (put) option is a decreasing (increasing) function of the volatility of the underlying. These predictions are strongly supported by the data. In the cross-section of equity option returns, returns on call (put) option portfolios decrease (increase) with underlying stock volatility. This finding is not due to cross-sectional variation in expected stock returns. It holds in various option samples with different maturities and moneyness, and it is robust to alternative measures of underlying volatility and different weighting methods.

Author: Cai Zhu
Publisher:
ISBN:
Category :
Languages : en
Pages : 63

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Book Description
In this paper, we explore the relation between information uncertainty and S&P 500 index option returns. Since underlying state variable affecting economy is unobservable, investors have to obtain their own estimations based on available information. During such procedure, it is inevitable that their results are contaminated by various kinds of noise signals. Therefore, investors cannot be 100% confident about the their estimations. We model such phenomena through incorporating investors' learning behavior into an equilibrium stochastic volatility model. In the model, we introduce noise signals as a stochastic process independent with economic fundamentals. Such information uncertainty is able to generate time-varying volatility for stock returns, even when volatility of economic fundamental is constant. As a source of risk, for investors with recursive preference, it is priced and is able to explain variance premium and cross-section index option returns. In order to test the model implication, empirically, we construct several proxies for information uncertainty. Consistent with model intuition, we show that information uncertainty as a systematic risk factor is able to explain variance premium term structure and has better performance to explain cross-section index option returns than traditional symmetric risk factors such as volatility and jump.

Author: Turan G. Bali
Publisher: John Wiley & Sons
ISBN: 1118589475
Category : Business & Economics
Languages : en
Pages : 512

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Book Description
“Bali, Engle, and Murray have produced a highly accessible introduction to the techniques and evidence of modern empirical asset pricing. This book should be read and absorbed by every serious student of the field, academic and professional.” Eugene Fama, Robert R. McCormick Distinguished Service Professor of Finance, University of Chicago and 2013 Nobel Laureate in Economic Sciences “The empirical analysis of the cross-section of stock returns is a monumental achievement of half a century of finance research. Both the established facts and the methods used to discover them have subtle complexities that can mislead casual observers and novice researchers. Bali, Engle, and Murray’s clear and careful guide to these issues provides a firm foundation for future discoveries.” John Campbell, Morton L. and Carole S. Olshan Professor of Economics, Harvard University “Bali, Engle, and Murray provide clear and accessible descriptions of many of the most important empirical techniques and results in asset pricing.” Kenneth R. French, Roth Family Distinguished Professor of Finance, Tuck School of Business, Dartmouth College “This exciting new book presents a thorough review of what we know about the cross-section of stock returns. Given its comprehensive nature, systematic approach, and easy-to-understand language, the book is a valuable resource for any introductory PhD class in empirical asset pricing.” Lubos Pastor, Charles P. McQuaid Professor of Finance, University of Chicago Empirical Asset Pricing: The Cross Section of Stock Returns is a comprehensive overview of the most important findings of empirical asset pricing research. The book begins with thorough expositions of the most prevalent econometric techniques with in-depth discussions of the implementation and interpretation of results illustrated through detailed examples. The second half of the book applies these techniques to demonstrate the most salient patterns observed in stock returns. The phenomena documented form the basis for a range of investment strategies as well as the foundations of contemporary empirical asset pricing research. Empirical Asset Pricing: The Cross Section of Stock Returns also includes: Discussions on the driving forces behind the patterns observed in the stock market An extensive set of results that serve as a reference for practitioners and academics alike Numerous references to both contemporary and foundational research articles Empirical Asset Pricing: The Cross Section of Stock Returns is an ideal textbook for graduate-level courses in asset pricing and portfolio management. The book is also an indispensable reference for researchers and practitioners in finance and economics. Turan G. Bali, PhD, is the Robert Parker Chair Professor of Finance in the McDonough School of Business at Georgetown University. The recipient of the 2014 Jack Treynor prize, he is the coauthor of Mathematical Methods for Finance: Tools for Asset and Risk Management, also published by Wiley. Robert F. Engle, PhD, is the Michael Armellino Professor of Finance in the Stern School of Business at New York University. He is the 2003 Nobel Laureate in Economic Sciences, Director of the New York University Stern Volatility Institute, and co-founding President of the Society for Financial Econometrics. Scott Murray, PhD, is an Assistant Professor in the Department of Finance in the J. Mack Robinson College of Business at Georgia State University. He is the recipient of the 2014 Jack Treynor prize.

Author: Amit Goyal
Publisher:
ISBN:
Category :
Languages : en
Pages : 38

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Book Description
We study the cross-section of stock options returns and find an economically important source of mispricing in individual equity options. Sorting stocks based on the difference between historical realized volatility and market implied volatility, we find that a zero-cost trading strategy that is long (short) in straddles, with a large positive (negative) difference in these two volatility measures, produces an economically important and statistically significant average monthly return. The results are robust to different market conditions, to firm risk-characteristics, to various industry groupings, to options liquidity characteristics, and are not explained by linear factor models.

Author: Kevin Aretz
Publisher:
ISBN:
Category :
Languages : en
Pages : 69

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Book Description
We study the effect of an asset's volatility on the expected returns of European options written on the asset. A simple stochastic discount factor model suggests that the effect differs depending on whether variations in volatility are due to variations in systematic or idiosyncratic volatility. While variations in idiosyncratic volatility only affect an option's elasticity, variations in systematic volatility also oppositely affect the underlying asset's risk. Since moneyness modulates these effects, systematic volatility positively (negatively) prices options with high (low) asset-to-strike price ratios, while idiosyncratic volatility is unambiguously priced. Single-stock call option data support our predictions.

Author: Robert A. Jarrow
Publisher:
ISBN:
Category : Derivative securities
Languages : en
Pages : 472

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Book Description
Written by a number of authors, this text is aimed at market practitioners and applies the latest stochastic volatility research findings to the analysis of stock prices. It includes commentary and analysis based on real-life situations.

Author: Dean Diavatopoulos
Publisher:
ISBN:
Category :
Languages : en
Pages : 33

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Book Description
Current literature is inconclusive as to whether idiosyncratic risk influences future stock returns and the direction of the impact. Prior studies are based on historical realized volatility. Implied volatilities from option prices represent the market's assessment of future risk and are likely a superior measure to historical realized volatility. We use implied idiosyncratic volatilities on firms with traded options to examine the relation between idiosyncratic volatility and future returns. We find a strong positive link between implied idiosyncratic risk and future returns. After considering the impact of implied idiosyncratic volatility, historical realized idiosyncratic volatility is unimportant. This performance is strongly tied to small size and high book-to-market equity firms.