Systematic Volatility Research Articles

CEO past distress experience and risk‐taking: Evidence from US property–liability insurance firms

AbstractWe investigate the relationship between CEOs' past distress experience and risk‐taking in US property–liability insurance companies. Our evidence shows that CEOs' past distress experience is negatively associated with insurers' risk‐taking behavior, suggesting that CEOs with distress experiences tend to take lower levels of risk in making financial decisions for their firms. The results are robust to using alternative measures of risk‐taking, including value at risk, expected shortfall, volatility of stock return, idiosyncratic volatility, systematic volatility, underwriting risk, and investment risk. Additionally, our results pass a placebo test, and we mitigate endogeneity concerns with the propensity score matching method.

A closer look at the relationship between firm-specific return variation and stock returns

PurposePrior studies use two measures of firm-specific return variation (FSRV): idiosyncratic volatility in absolute and relative terms, the latter of which is also termed stock price nonsynchronicity. Whereas most research focuses on investigating the idiosyncratic volatility puzzle, the authors carry out comparison of these two measures and further investigate which of the two constituents of nonsynchronicity explain the association between FSRV and stock returns, emphasising the importance of assessing which component drives stock returns.Design/methodology/approachThe authors use the US individual stock returns from 1925 to 2016 and define the two measures of FRSV based on the Fama and French (1993) model. Specifically, the authors decompose the relative measure into two components: (i) absolute idiosyncratic volatility and (ii) systematic volatility. The authors conduct various tests based on high-minus-low, zero-investment quintile portfolio sorts and perform the Fama–MacBeth analysis by singling out each component.FindingsThe authors find a positive return on the portfolio sorted on relative idiosyncratic volatility or on systematic volatility, but find a negative return sorted on absolute idiosyncratic volatility. The results are robust after controlling for size, BM and other risk characteristics using a double-sorting approach. The Fama–MacBeth regression results show that a positive association between the relative measure and stock returns is driven primarily by the low-systematic-volatility anomaly across firms. The findings are robust to controlling for return residual momentum, skewness, jumps and information discreteness.Originality/valueExtant research posits the idiosyncratic volatility puzzle and the low-volatility anomaly. The authors emphasize the importance of integrating these two streams of research. This study enhances the understanding of the driving force underlying the relationship between FSRV and cross-sectional stock returns.

Idiosyncratic volatility in commodity futures markets: measurement and puzzle

PurposeThis paper aims to propose an alternative method to measure idiosyncratic volatility and test whether the idiosyncratic volatility puzzle holds in commodity futures markets.Design/methodology/approachThis paper proposes a partially new measure of idiosyncratic volatility in commodity futures markets based on the Schwartz and Smith (2000) short-term/long-term model. This model enables us to capture systematic risks of commodity futures markets in a parsimonious way.FindingsUsing a sample of futures contracts for 20 commodities from 1973 to 2022, this paper demonstrates that idiosyncratic volatility is more significant than systematic volatility in commodity futures markets, and that the idiosyncratic volatility puzzle does not hold in these markets. This paper also performs robustness tests to investigate whether the puzzle holds during subsample periods when commodity markets are more volatile and find consistent results. This study highlights the differences between commodity futures markets and equity markets and emphasizes the importance of investigating idiosyncratic volatility in commodity futures markets.Originality/valueThe contributions of this paper are threefold. First, this paper contributes to the literature by focusing on the idiosyncratic volatility of commodity futures returns. Second, this paper constructs a partially new measure of idiosyncratic volatility in commodity futures markets. Finally, this paper also contributes to the literature on the idiosyncratic volatility puzzle and demonstrates that the puzzle may not exist in commodity futures markets.

Price informativeness: a potential explanation for the idiosyncratic volatility puzzle

ABSTRACT Price informativeness is the amount of private information incorporated into stock prices and measured by from regressions of stock returns on systematic risk factors. While is closely related with idiosyncratic volatility, it is not interchangeable because magnitude of systematic volatility simultaneously changes. By controlling for the systematic volatility using the double-sorting portfolio approach, we suggest a potential involvement of price informativeness with the idiosyncratic volatility puzzle. Both cross-sectional evidence of monotonic and inverse relationship between idiosyncratic volatility and and time-series evidence of disappearing alphas of the low-minus-high idiosyncratic volatility portfolios during recessions support an explanation of the idiosyncratic volatility puzzle in association with price informativeness.

Does Economic Policy Uncertainty Affect Green Bond Markets? Evidence from Wavelet-Based Quantile Analysis

ABSTRACT This paper investigates the wavelet-based quantile dependence between Economic Policy Uncertainty (EPU) and green bond markets over 2014–2021. We first determine how the connectivity between EPU and green bonds differs across different investment horizons by decomposing EPU and green bond series into various frequency bands. Next, we provide a quantile-based framework to characterize the reliance between EPU and green bond markets across various market circumstances. Our findings show that the Granger causality from EPU to the green bond market is non-linear and varies across time scales. Our results benefit policymakers with a policy design to mitigate systematic volatility caused by external shocks in the green bond markets.

Does ETF activity reduce stock price volatility—Evidence from the A-share market

ABSTRACT The scale of global exchange-traded funds (ETFs) has shown an explosive growth trend; however, research on the impact of ETF activity on the stock market is still in its infancy. While ETFs increase the volatility of the U.S. stock market, there is scant literature on the impact of ETF activity on the volatility of the emerging A-share market. Owing to the large differences in the institutional and investor structure of the A-share market, will there be significant differences in the impact of ETFs on the volatility of the A-share market? This study found that ETF activity significantly reduced idiosyncratic volatility but increased systemic volatility. Since the decrease in idiosyncratic volatility was greater than the increase in systemic volatility, the overall volatility showed a downward trend. Further research on the impact mechanism showed that the idiosyncratic volatility of the A-share market was positively correlated with noise information. ETF activity reduced idiosyncratic volatility by reducing the noise information. Systematic volatility was positively correlated with faster information integration speed. ETF activity improved systematic volatility by improving information integration speed. This study elucidated the impact of ETF activity on stock price volatility under different market backgrounds.

Moneyness, Underlying Asset Volatility, and the Cross-Section of Option Returns

Abstract We study the effect of an asset’s volatility on the expected returns of European options on the asset. Deriving predictions from a stochastic discount factor model, we show that the effect depends on whether variations in the asset’s volatility are driven by systematic or idiosyncratic volatility. While idiosyncratic-volatility-induced variations only affect the option elasticity, systematic-volatility-induced variations also oppositely affect the expected return of the asset. Since the expected asset return (elasticity) effect dominates for options with more linear (non-linear) payoffs, systematic volatility prices sufficiently in-the-money (out-of-the-money) options with the opposite (same) sign as idiosyncratic volatility. Using single-stock calls as test assets, double-sorted portfolios and Fama–MacBeth (1973) regressions broadly support the model’s predictions.

The Revival of Business Groups’ Risk Sharing: Evidence from Japanese Real Estate Investment Trust Market

AbstractWe examine the business groups’ risk-sharing hypothesis in the Japanese Real Estate Investment Trust (REIT) market in which the unique external management system seems to be reinforcing power relationships among firms affiliated with the modern Japanese business groups, called keiretsu. We find that REITs whose sponsors belong to one of the keiretsu groups (keiretsu REITs) have significantly lower volatility of profitability than REITs whose sponsors do not belong to the keiretsu groups (non-keiretsu REITs). There is no significant difference in profitability between keiretsu REITs and non-keiretsu REITs, controlling for firm and property characteristics. The abnormal portion of the profitability unexplained by firm characteristics is also significantly lower with keiretsu REITs. We also find that the keiretsu affiliation reduces the systematic volatility of affiliated REITs, while such an effect is not observed with the idiosyncratic volatility, suggesting that the risk-sharing effect may be beneficial for the value of REITs. Using the difference-in-differences design with propensity score matching, we find that the negative impact of the Great East Japan Earthquake on the profitability was significantly smaller with keiretsu REITs than with non-keiretsu REITs. Keiretsu REITs were also able to stabilize their capital structure by shifting some short-term debts to long-term debts without increasing the cost of loans under the uncertain situation caused by the Earthquake. Keiretsu REITs were able to borrow money from their affiliated group banks even right after the earthquake, while non-keiretsu REITs seem to have struggled to secure loans from those banks.

Systematic Volatility Risk and Its Cross-sectional Determinants

We empirically examine whether investors demand a systemic component of Volatility Risk (VRP-beta) using the stock options traded on National Stock Exchange, India. We document robust evidence on the presence of VRP-beta, which survives even after accounting for the traditional Fama-French factors. We also explore possible determinants of VRP-beta. Further, we find VRP-beta is positively related to the hedging demand of tail risk and negatively associated with the options market liquidity, but unrelated to the size and volatility of the stock. Our results are robust to alternate specifications of realized volatility calculated at different sampling frequencies.

Beta, Growth, and Size: Early 2020 as a Signal Through the Noise on Covariation Among Individual Stocks

It is hard to get evidence on the pricing of individual stocks (rather than portfolios) because firm-specific volatility is too large relative to systematic volatility. In February and March 2020, however, the S&P500 fell by extraordinary amounts and then rose by an extraordinary amount in April 2020. Here I report strong associations with return and beta, book-to-market, and size in each of those months. The evidence suggests that each of these three sources of covariation likely traces directly to business distress and not necessarily to investor utilities over consumption except in the theoretically-trivial sense that investors prefer more money to less.

Single Stock Options and Systematic Volatility Risk: Evidence from India

Extant empirical evidence on volatility risk premium in emerging markets is limited to the market level index options. This study extends of understanding of volatility risk premium in single stock options in the Indian market. The study finds that volatility risk is priced systematically among the single stock options and the results are robust to alternative specifications of volatility and sampling frequencies. The study then examines the cross-sectional determinants of the systematic risk and finds that the options' systematic volatility risk is positively related to the hedging demand of tail risk and negatively associated with the options market liquidity.

Dancing to the Same Tune: Commonality in Securities Lending Fees

We document that there is commonality in the loan fees that short sellers pay, and the common component of loan fees explains a significant amount of their variation. The time series of the loan fee common component is highly correlated with several well-documented asset pricing and macro factors, suggesting that loan fee commonality is associated with states of the world that are consequential to investors. At the asset level, we compute sensitivities of stocks’ loan fees to the loan fee common component and document that stocks with high loan fees tend to also exhibit high sensitivity to the loan fee common component. While controlling for other priced short-selling factors, we document a statistically significant negative relationship between the systematic volatility of loan fees (with respect to the loan fee common component) and stock returns, indicating that this commonality is priced in the cross-section of stock returns. In addition to this pricing implications, we present evidence that loan fee commonality is associated with lower price efficiency, suggesting that loan fee commonality is an important limit to arbitrage. Finally, we present evidence that loan demand may be the primary driver of the observed fee commonality.

Equity Option Pricing with Systematic and Idiosyncratic Volatility and Jump Risks

Recently, a large number of empirical studies indicated that individual equity options exhibit a strong factor structure. In this paper, the importance of systematic and idiosyncratic volatility and jump risks on individual equity option pricing is analyzed. First, we propose a new factor structure model for pricing the individual equity options with stochastic volatility and jumps, which takes into account four types of risks, i.e., the systematic diffusion, the idiosyncratic diffusion, the systematic jump, and the idiosyncratic jump. Second, we derive the closed-form solutions for the prices of both the market index and individual equity options by utilizing the Fourier inversion. Finally, empirical studies are carried out to show the superiority of our model based on the S&P 500 index and the stock of Apple Inc. on options. The out-of-sample pricing performance of our proposed model outperforms the other three benchmark models especially for short term and deep out-of-the-money options.

How Close is the Implied Volatility Derived from Black Scholes for Individual Stocks to VIX

The implied volatility derived from Black Scholes model represents total volatility which includes both systematic and unsystematic components. The purpose of this paper is to examine the accuracy of the implied volatility derived by Black Scholes (after excluding the unsystematic component) with reference to VIX, which is a widely used proxy for market (systematic) volatility. We utilize CAPM to extract the volatility linked to systematic component for the 30 individual stocks within Dow Jones and compare them to VIX. The systematic volatility for these stocks adjusted for beta turn out to be rather close to the VIX, which implied that CAPM is an effective approach for separating market risk from total risk.

Asymptotics for the systematic and idiosyncratic volatility with large dimensional high-frequency data

In this paper, we decompose the volatility of a diffusion process into systematic and idiosyncratic components, which are not identified with observations discretely sampled from univariate process. Using large dimensional high-frequency data and assuming a factor structure, we obtain consistent estimates of the Laplace transforms of the systematic and idiosyncratic volatility processes. Based on the discrepancy between realized bivariate Laplace transform of the pair of systematic and idiosyncratic volatility processes and the product of the two marginal Laplace transforms, we propose a Kolmogorov–Smirnov-type independence test statistics for the two components of the volatility process. A functional central limit theorem for the discrepancy is established under the null hypothesis that the systematic and idiosyncratic volatilities are independent. The limiting Gaussian process is realized by a simulated discrete skeleton process which can be applied to define an approximate critical region for an independence test.

Corporate liquidity and risk management with time-inconsistent preferences

This paper extends the model of corporate liquidity and risk management with limited commitment by incorporating time-inconsistent preferences. With respect to the firm's liquidity w = W∕K, it predicts that in the presence of time-inconsistency, the entrepreneur optimally responds by lowering the maximal debt capacity, over-consuming, under-investing and reducing both the idiosyncratic and systematic volatility of w. When disentangling the entrepreneur's belief with regard to future selves' time-inconsistent behavior, as a result of sophistication effect, the sophisticated entrepreneur reduces the endogenous debt capacity, invests less, decreases consumption, engages less in financial hedging and allocates even smaller liquid assets in the market portfolio than naive entrepreneur.

Risk aversion heterogeneity and the investment–uncertainty relationship

We develop a dynamic macroeconomic model encompassing heterogeneity in households’ attitudes towards risk, and we allow agents to share aggregate volatility by trading safe assets. In equilibrium, when volatility increases, low-risk-averse households, who hold a long position in risky assets, perceive a higher certainty-equivalent future return on capital. The perceived yield may also increase for high-risk-averse agents, who hold riskless assets. In response to a rise in certainty-equivalent expected returns, savings decrease due to a limited willingness to substitute consumption over time. This generates a negative response of aggregate investment to an increase in systematic volatility, showing that the aggregate behavior of an heterogeneous agents economy can be different from the behavior originating from an ‘average’ representative agent. The appearance of degenerate wealth distributions is avoided by allowing the risk aversion of each household to change stochastically over time.

On the terrorism of money and national policy-making in emerging capitalist economies

Is national state policy-making more constrained by capitalist value-disciplines in emerging capitalist economies (ECEs) than it is in advanced capitalist countries? In order to explore this question, this article offers a spatialised form-analysis of the imperative that the capital relation imposes upon the form of the state in ECEs. The approach, grounded in the Marxian critique of political economy, integrates crucial insights from radical economic geography and Post-Keynesian/Minskian economics. I show that despite growing integration into the financial world market, ECEs have retained a subordinate positionality in what I call the relational geographies of money-power, and which are constituted by two overlapping sets of geographies: the geographies of the global monetary system, and the geographies of the global financial system. As a result, the contradiction between capital, money and the state takes a more acute form of realisation in ECEs than in advanced capitalist countries, making the management of monetary and financial affairs more difficult for the capitalist state. This, I argue, constitutes an additional layer of social determination on national policy-making in ECEs. More concretely, this manifests itself as a systematic volatility of exchange rates and a tendency to high real interest rates, enhanced scrutiny of national policy-making by international investors, rapidly shifting financial reputation and high pro-cyclicality of money-capital inflows, the build-up of specific forms of external vulnerability, brutal money-capital flight during financial distress, and heavy dependence on monetary policy in advanced capitalist countries. I conclude by discussing theoretical and political-strategic implications for labour-centred development.

What Drives Corporate Asset Prices: Short- or Long-Run Risk?

This paper addresses this question with an asset-pricing model featuring endogenous corporate policies. Long-run risk reflects a firm’s profit exposure to slowly-moving expected consumption growth, whereas short-run risk captures the exposure to frequent unexpected changes in consumption growth. Long-run risk reduces a firm’s optimal leverage while driving most of the equity risk premium. The contribution of short-run risk increases during expansions and for firms with higher idiosyncratic volatility, but remains similar across levels of default risk and systematic volatility. These findings contribute to understanding the expected return on a stock, both over time and in the cross-section.

Sector Option Implied Volatility Dynamics and Predictability

As research is revealing more detail about the behavior of implied volatilities, the empirical evidence points to important differences between systematic volatility, that is correlated with the market index and is shared broadly across stocks, and idiosyncratic volatility that is largely independent of the rest of the market. It is the former that appears to command a significant variance risk premium in market prices. Marks and Simon examine an intermediate case: options on sector exchange traded funds. The underlying asset for an ETF is a portfolio of stocks within a single market sector. That is, the underlying is an index not a single stock, so volatility risk is somewhat systematic, but to the extent there is an important industry component to variance, it might behave more like single-stock idiosyncratic risk than like market risk. The results show a rich array of volatility effects, both in terms of different risk premia on different types of volatility, but also in terms of the speed of adjustment of sector IVs that appear to revert toward a relatively constant long term average relationship with systematic risk after deviating from it temporarily. Among other interesting results in the study: both market and sector IVs respond to realized returns, but sector “idiosyncratic” IVs are more symmetrical in responding to positive and negative returns; however, the impact of a negative return appears immediately, while sector IVs respond more slowly to positive returns. Overall, the article provides new evidence showing the rich structure of implied volatility dynamics.