Issues in the use of implied volatility

• Main Author: Salih, Aslihan Altay
• Format: Dissertation
• Language: English
• Published: ProQuest Dissertations & Theses 01-01-1995
• Subjects: Finance
• ISBN: 9798208602713

Futures and options markets offer various economic functions. Futures markets have been shown to offer price discovery, asset management and risk management services. Options markets provide similar price discovery and risk management alternatives. In addition, options markets provide a market based estimate of the underlying asset's implied volatility. In the finance literature implied volatility has been employed, in various ways: (1) forecasting future cash market volatility, (2) testing the efficiency of the options markets, and (3) measuring the effect of macroeconomics releases on changes in market and firm volatility. This study contains three essays which extend previous research in implied volatility. The existence of non-stationarity in investors' desired risk premia remains a central topic in financial research. Chapter 1 gives a brief introduction to the study. Chapter 2 reviews the related recent literature. In Chapter 3 implied volatilities are used to investigate empirically the volatility risk premium of S&P 500 Index options. In addition we test for the effects of endogenous and exogenous variables in explaining the volatility risk premium during varying periods of expected uncertainty. In Chapter 4 various statistical methods (ARCH, GARCH) are analyzed and used to test the additional information content of implied volatility on S&P 500 options that are not captured by lagged market variances. Finally previous research has suggested a relationship between expected return and relative expected risk. Under these theoretical models expected asset return should reflect expected risk. In Chapter 5 a test for effectiveness of implied volatility as a basis for market timing decisions between stock and bond markets has been conducted.