Ex-ante Volatility Research Articles

The impact of cost stickiness on income smoothing: evidence from employment protection regulations

Prior literature suggests that cost stickiness increases the ex-ante volatility and reduces the predictability of earnings. We examine whether managers intentionally undo such consequences by dampening earnings volatility. Exploiting the staggered adoption of wrongful discharge laws as an exogenous instrument for cost stickiness, we document that cost stickiness increases managers’ income-smoothing activities. This response is more pronounced in firms whose earnings are more sensitive to labour costs than their industry peers are and in firms with stronger information-provision incentives. Additional analyses indicate that income smoothing improves sticky-cost firms’ earnings informativeness and that the identified impact of cost stickiness is primarily driven by labour costs. Our results suggest that labour regulations can influence managers’ financial reporting incentives via cost behaviour.

Estimating Stochastic Volatility Model with Realized Volatility and Implied Volatility

We examine a group of extended realized stochastic volatility (RSV) models with ex-ante volatility information added to the framework. The most advantageous specification is the one with implied volatility (IV) as an explanatory variable in the latent volatility process, which produces an estimated latent volatility almost identical to the realized volatility. Including IV generalizes the traditional AR(1) specification of the volatility process to a market-based process, which captures the dynamics of the daily realized volatility. The purposed RSV model with IV outperforms all benchmark models in out-of-sample return density prediction. The empirical finding is valid for both equity index and major individual stocks for a data sample with daily observations over twenty years.

Implied volatility and the cross section of stock returns in the UK

The paper examines the relationship and the cross-sectional asset pricing implications of risk arising from the innovations in the short and the long-term implied market volatility on excess returns of the FTSE100 and the FTSE250 indices and the 25 value-weighted Fama-French style portfolios in the UK. Findings suggest that after controlling for valuation, macroeconomic, leading economic and business cycle indicators, returns exhibit a strong negative relationship with the innovations in both the short and the long-term implied market volatility. The cross-sectional regression provides new evidence that changes in both short and long-term implied market volatility are significant asset pricing factors with negative prices of risk, which suggests that (i) investors care about ex-ante volatility and (ii) they are willing to pay for insurance for future uncertainty.

International Volatility Arbitrage

Are options on exchange-traded products (ETPs) and indexes consistently priced internationally? The cross-section of international option returns exhibits a mispricing by sorting on ex-ante volatility returns. In addition, selling international ETP options and buying their corresponding index options commands a positive risk premium. Both empirical findings are economically large and pervasive internationally, whereas they are comparably small domestically. While volatility hedge funds are exposed towards domestic option products, they neglect the possibility of engaging in foreign volatility arbitrage. These findings entail that alpha seekers may expand their horizon towards international derivatives which at first glance are similar, but institutionally are not.

Banks' earnings: Empirical evidence of the influence of economic and financial market factors

The structure of income is a foremost address within research on banks' performance, especially with regard to effects on the resilience of banks' earnings. Indeed, given their central position in the economy, banks shall thrive to generate sustainable earnings and control for their potential volatility. Existing studies mostly consider the weight of non-net interest income (nonNII) as opposed to the traditional NII income source. Such aggregated nonNII is found to increase earnings risk but more granular studies conflict. We propose an original investigation of the influence of economic and financial conditions on various income types, assuming that performance may actually be driven by both the income structure and external conditions.We focus European banks, which have long been allowed to diversify beyond retail banking. Out of a straight panel framework, we question if the influence of external conditions spreads to earnings components other than credit losses and trading income and if it does allow for diversification benefits among components. We find that each component actually evolves owing to its own equation. Furthermore, effects of single variables may cumulate over different components of earnings (e.g. GDP) or provide with diversification benefits. These effects are all the more important since they are not mitigated by operating expenses. Hence, over a regarded period, banks' performance depends upon their structure of income and upon volatilities and correlations of influential variables. Besides controlling for ex-ante volatility, our approach shows that a given structure of income is not necessarily more resilient than others but that selected non-banking income may support a higher stability of earnings.

A New Test for Cross-Sectional Momentum

This paper revisits the empirical finding that there is no momentum in the cross-section of investment-grade corporate bonds. Using a comprehensive dataset of investment grade and high yield USD corporate bonds from 1994 to 2015, I find that the large dispersion in volatility between corporate bonds causes standard decile portfolio sorts to be far from an optimal momentum portfolio as suggested by theory. Scaling bonds, i.e. momentum signals and positions, with an ex-ante estimate of volatility remedies this problem and reveals significant momentum effects. The momentum effect cannot be attributed to systematic risk, is robust to the choice of the ex-ante volatility measure, is present across formation and holding period lengths and is not driven by liquidity.

Trading the VIX Futures Roll and Volatility Premiums with VIX Options

This study examines the efficiency of VIX option trading strategies that exploit the VIX futures roll and the often substantial VIX futures volatility premiums from January 2007 through March 2014. The study first assesses the related issue of whether VIX options typically are overpriced by examining long VIX option delta-hedged returns and demonstrates that average losses on front contract calls and puts over 5-business day horizons either are not statistically significant or are economically small. In light of the evidence that VIX option buyers on average do not overpay at all or by much for the limited risk associated with VIX options, the study then turns to whether long VIX option positions can be used to exploit the well-documented tendencies of VIX futures to rise and fall when the VIX futures curve is in backwardation and in contango, respectively, as well as the tendency of VIX futures to build in large ex-ante volatility premiums. The results demonstrate that these defined-risk strategies are highly profitable and offer attractive risk-reward tradeoffs. Moreover, the systematic tendencies of VIX futures have far more power for predicting attractive VIX option returns than the ex-ante volatility premiums built into VIX options. The study also shows that long VIX option strategies importantly benefit from a strong tailwind that owes to the tendency of VIX option implied volatilities to rise with increases in the actual volatilities of underlying VIX futures contracts, as VIX futures move toward settlement and their volatilities rise to the typically higher volatility of the VIX.

The forecasting performance of implied volatility index: evidence from India VIX

In this paper, we investigate the forecasting performance of ex-post an ex-ante volatility forecasts against realized return volatility of various time horizon. The competing volatility forecasts are implied volatility, RiskMetrics and GJR-GARCH; the empirical results uncover that implied volatility dominates the other volatility forecast in the prediction of future realized return volatility. The in-sample forecast suggests that ex-ante volatility best explains the future market volatility. The non-overlapping sampling procedure gives the more robust estimate of volatility forecasts, the results reveals that implied volatility forecasts of all horizon appears positive unbiased forecaster of realized volatility. Moreover, the instrumental variable estimation in the presence of error-in-variable clears that implied volatility is free from measurement error; OLS estimates remains more consistent than the 2SLS estimates. The information content of implied volatility encourages the exchanges to construct the implied volatility indices and volatility products on underlying volatility index.

Persistence of ex-ante volatility and the cross-section of stock returns

We suggest a new measure of total ex-ante volatility (EAV) in stock returns, which includes traditional non-market (or idiosyncratic) risk and the unexpected component of market return. We find that the portfolio-level EAV measure exhibits strong predictive power for the cross-section of average returns during the post-1963 period. We demonstrate that (1) the persistence of EAV gives rise to economically significant spread in returns between value and growth stocks, and (2) the cross-sectional dispersion in stock returns is positively related to the estimated value of EAV. The benefit of the EAV measure is that it is countercyclical and contains relevant information about the time-variation in value premium.

On the Linkages among Ex-ante and Ex-post Volatility: Evidence from NSE Options Market (India)

This article investigates the cointegration level, and changes in the existence and direction of causality among volatilities. Vector autoregressive (VAR) model enables us to conduct Granger-causality and impulse response analysis, and determine the pattern of causality. The empirical findings uncover that ex-ante volatility best impounds the market-wide information to explain the ex-post volatility. Vector autoregression results make clear that unidirectional causality exists among ex-ante and ex-post volatilities. Impulse response analysis explains that realized volatility declines significantly initially in the first two periods and remains constant for all other periods. Findings, emphasizes that implied volatility is more informative on volatility forecasting, useful for successful volatility traders and pricing of options.

Reward‐to‐Risk Ratios in the Treasury‐Bill Market

AbstractWe estimate the ex‐ante reward per unit of spot‐rate volatility (the reward‐to‐risk ratio) for U.S. Treasury bills on a monthly basis and find that these ratios vary predictably over time. Reward‐to‐risk ratios are positively autocorrelated; month‐to‐month changes in these ratios are negatively autocorrelated. Variation in these ratios contributes at least as much variation to ex‐ante excess returns as does variation in interest‐rate volatility. Because ex‐ante volatility and the rewards to volatility vary independently, variation in ex‐ante premiums is greater than the variation attributable to changing volatility alone.

Excess Returns and Risk at the Long End of the Treasury Market: An Egarch-M Approach

This paper models weekly excess returns of 10-year Treasury notes and long-term Treasury bonds from 1968 through 1993 using an exponential generalized autoregressive conditional hetroskedasticity in mean (EGARCH-M) approach. The results indicate the presence of conditional hetroskedasticity and a strong tendency for the ex-ante volatility of excess returns to increase more following negative excess return innovations compared to positive innovations of equal magnitude. In addition, increases in ex-ante volatility are associated in some subperiods with rising excess returns on longer-term instruments, although the slope of the yield curve and lagged excess returns generally remain significant predictors of excess returns.