Hostname: page-component-586b7cd67f-t7czq Total loading time: 0 Render date: 2024-11-26T11:05:34.976Z Has data issue: false hasContentIssue false

Stock Returns, Implied Volatility Innovations, and the Asymmetric Volatility Phenomenon

Published online by Cambridge University Press:  06 April 2009

Patrick Dennis
Affiliation:
[email protected], McIntire School of Commerce, University of Virginia, Charlottesville, VA 22904
Stewart Mayhew
Affiliation:
[email protected], Office of Economic Analysis, U.S. Securities and Exchange Commission, Washington, DC 20549
Chris Stivers
Affiliation:
[email protected], Department of Banking and Finance, Terry College of Business, University of Georgia, Athens, GA 30602.

Abstract

We study the dynamic relation between daily stock returns and daily innovations in optionderived implied volatilities. By simultaneously analyzing innovations in index- and firmlevel implied volatilities, we distinguish between innovations in systematic and idiosyncratic volatility in an effort to better understand the asymmetric volatility phenomenon. Our results indicate that the relation between stock returns and innovations in systematic volatility (idiosyncratic volatility) is substantially negative (near zero). These results suggest that asymmetric volatility is primarily attributed to systematic market-wide factors rather than aggregated firm-level effects. We also present evidence that supports our assumption that innovations in implied volatility are good proxies for innovations in expected stock volatility.

Type
Research Article
Copyright
Copyright © School of Business Administration, University of Washington 2006

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Andersen, T.; Bollerslev, T.; Diebold, F. and Ebens, H.. “The Distribution of Realized Stock Return Volatility.” Journal of Financial Economics, 61 (2001), 4376.CrossRefGoogle Scholar
Avramov, D.; Chordia, T.; and Goyal, A.. “The Impact of Trades on Daily Volatility.” Review of Financial Studies, forthcoming (2006).CrossRefGoogle Scholar
Bakshi, G., and Kapadia, N.. “Volatility Risk Premiums Embedded in Individual Equity Options: Some New Insights.” Journal of Derivatives, Fall (2003a), 4554.CrossRefGoogle Scholar
Bakshi, G., and Kapadia, N.. “Delta-Hedged Gains and the Negative Market Volatility Risk Premium.” Review of Financial Studies, 16 (2003b), 527566.CrossRefGoogle Scholar
Bakshi, G.; Kapadia, N.; and Madan, D.. “Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options.” Review of Financial Studies, 16 (2003), 101143.CrossRefGoogle Scholar
Bekaert, G., and Wu, G.. “Asymmetric Volatility and Risk in Equity Markets.” Review of Financial Studies, 13 (2000), 142.CrossRefGoogle Scholar
Benzoni, L.Pricing Options under Stochastic Volatility: An Empirical Investigation” Working Paper, Univ. of Minnesota (2002).Google Scholar
Black, F.Studies of Stock Price Volatility Changes.” Proceeding of the 1976 Meetings of the American Statistical Association, Business and Economic Statistics Section (1976), 177181.Google Scholar
Blair, B.; Poon, S. and Taylor, S.. “Forecasting S&P 100 Volatility: The Incremental Information Content of Implied Volatilities and High-Frequency Index Returns.” Journal of Econometrics, 105 (2001), 526.CrossRefGoogle Scholar
Bollen, N., and Whaley, R.. “Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?Journal of Finance, 59 (2004), 711753.CrossRefGoogle Scholar
Bollerslev, T., and Wooldridge, J.. “Quasi-Maximum Likelihood Estimation Inference in Dynamic Models with Time-Varying Covariances.” Econometric Theory, 11 (1992), 143172.Google Scholar
Chernov, M.Implied Volatilities as Forecasts of Future Volatility, Time-Varying Risk Premia, and Returns Variability.” Working Paper, Columbia Univ. (2001).CrossRefGoogle Scholar
Christensen, B., and Prabhala, N.. “The Relation between Implied and Realized Volatility.” Journal of Financial Economics, 50 (1998), 125150.CrossRefGoogle Scholar
Christie, A.The Stochastic Behavior of Common Stock Variances—Value, Leverage, and Interest Rate Effects.” Journal of Financial Economics, 10 (1982), 407432.CrossRefGoogle Scholar
Coval, J., and Shumway, T.. “Expected Option Returns.” Journal of Finance, 56 (2001), 9831009.CrossRefGoogle Scholar
Cox, J., and Ross, S.. “The Valuation of Options for Alternative Stochastic Processes.” Journal of Financial Economics, 3 (1976), 145166.CrossRefGoogle Scholar
Dennis, P., and Mayhew, S.. “Risk-Neutral Skewness: Evidence from Stock Options.” Journal of Financial and Quantitative Analysis, 37 (2002), 471493.CrossRefGoogle Scholar
Fleming, J.The Quality of Market Volatility Forecasts Implied by S&P 100 Index Option Prices.” Journal of Empirical Finance, 5 (1998), 317345.CrossRefGoogle Scholar
Fleming, J.; Ostdiek, B. and Whaley, R.. “Predicting Stock Market Volatility: A New Measure.” Journal of Futures Markets, 15 (1995), 265302.CrossRefGoogle Scholar
Ghysels, E.; Santa-Clara, P.Valkanov, R.. “There is a Risk-Return Tradeoff after All.” Journal of Financial Economics, 76 (2005), 509548.CrossRefGoogle Scholar
Glosten, L.; Jagannathan, R.; and Runkle, D.. “On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks.” Journal of Finance, 48 (1993), 17791802.CrossRefGoogle Scholar
Harvey, C., and Siddique, A.. “Autoregressive Conditional Skewness.” Journal of Financial and Quantitative Analysis, 34 (1999), 465487.CrossRefGoogle Scholar
Heston, S.A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options.” Review of Financial Studies, 6 (1993), 327344.CrossRefGoogle Scholar
Lamoureux, C., and Lastrapes, W.. “Forecasting Stock-Return Variances: Toward an Understanding of Stochastic Implied Volatilities.” Review of Financial Studies, 6 (1993), 293326.CrossRefGoogle Scholar
Mayhew, S., and Stivers, C.. “Firm-Level Stock Return Dynamics, Option Volume, and the Information Content of Implied Volatility.” Journal of Futures Markets, 23 (2003), 615646.CrossRefGoogle Scholar
Pan, J.The Jump-Risk Premia Implicit in Options: Evidence from an Integrated Time-Series Study.” Journal of Financial Economics, 63 (2002), 350.CrossRefGoogle Scholar
Poteshman, A.Forecasting Future Volatility from Option Prices.” Working Paper, Univ. of Illinois at Urbana-Champaign (2000).CrossRefGoogle Scholar
Whaley, R.Derivatives on Market Volatility: Hedging Tools Long Overdue.” Journal of Derivatives, 1 (1993), 7184.CrossRefGoogle Scholar
Wu, G.The Determinants of Asymmetric Volatility.” Review of Financial Studies, 14 (2001), 837859.CrossRefGoogle Scholar