Volatility Premium Research Articles

Operational Efficiency based Investment strategies and Equity Returns: Evidence from Emerging Economy

The objective of this paper is to study the impact of market premium, asset growth, net operating assets and volatility premium on future stock returns. This study uses secondary data of monthly closing stock prices of hundred non-financial companies, listed in Pakistan Stock Exchange (PSX). The sample period of the study consists of 20 years from Jun-1998 to Jun-2018 with 2000 firm year observations. The research methods used are quantitative research along with deductive approach. In logical and scientific methods, the needed data is collected from the official website of PSX. This study is descriptive in nature and relationship between variables is measured using Regression Analysis. The results of the study show that market premium and volatility premium have positive and significant impact on stock returns. Whereas, asset growth premium and net operating asset premium have mixed pattern.
 
 Keywords: Pakistan Stock Exchange, Regression Analysis, Market Premium, Asset Growth, Volatility, Net Operating Assets

A Comparison of the Performance of Rainbow Options and Stocks under COVID-19 and Ukraine Conflict

This paper hopes to explore which is the better choice for investors under the different environments of the US stock market, rainbow option or buying a single stock. Due to the improvement of the COVID-19 situation in the United States in 2021 and the introduction of government policies to stimulate the economy, the US stock market showed an upward trend throughout 2021. In 2022, due to the conflict between Russia and Ukraine, the global economy will be impacted, and the US stock market is no exception. In these two long-term bear markets and bull markets, it hopes to find a mutation option to control risks and improve returns. In this case, it focuses on rainbow options, which are options that help investors screen out the better-performing stocks or futures included in them. First, this paper paired 14 stocks in five fields, calculated the option’s payoff according to the rainbow option's rules, and then compared it with the return of the stock alone to explore the superiority of the rainbow option. The return on the rainbow option is higher than the return on any single stock. Then the option is simulated and priced for 1000 future trading days so as to obtain the return of the rainbow option under the assumption of stable fluctuation in the US stock market environment, which is used as the reference for pricing. Finally, the sensitivity analysis of options is conducted to study the main factors affecting the volatility of option premiums. The result is that the moves in rainbow options are always correlated with the stock that is more active.

Credit default swap premium volatility and its relationship with selected macroeconomic variables: the case of Turkiye

Bu çalışmada uygulamanın ilk kısmında Türkiye’nin ülke risk priminde gözlenen volatilite 2004-2022 dönemi için incelenmiştir. Daha sonra ülke risk primi ile seçili makroekonomik değişkenler (dolar kuru, enflasyon, faiz ve BİST-100) arasındaki kısa ve uzun dönemli ilişki araştırılmıştır. Bu bağlamda çalışmada ARMA(3,3)-GJR GARCH (1,1) modeli ile volatilite modellemesi yapılmış ve daha sonra ARDL sınır testi uygulanmıştır. Volatilite modellemesi sonucunda ülke risk primi sistemine gelen şokların volatilite direnci düşük çıkmıştır. Yine volatilite modellemesi sonucunda Asimetri katsayısına göre sistemde kaldıraç etkisi bulunmamaktadır. İncelenen dönemin uzun bir zaman dilimi olduğu göz önünde bulundurularak seride olabilecek yapısal kırılmalar, Varyansta Kırılma testi ile incelenmiş ve bulunan dört kırılma tarihi modele dâhil edilmiştir. Varyans denkleminde kırılma tarihlerinin dâhil edildiği modelin geçersiz çıkması sonucu ile volatilite direncinin düşük çıkması, birbirini destekleyen sonuçlar olarak dikkati çekmektedir. ARDL sınır testi sonucunda ülke risk primleri ile modelde kullanılan makroekonomik değişkenler arasında uzun dönemli eşbütünleşme ilişkisi belirlenmiştir. ARDL modelinde kısa ve uzun dönem birlikte dikkate alındığında ülke risk primleri üzerinde etki gücü en yüksek faktörün sermaye piyasası olduğu belirlenmiştir. Uzun dönemde fiyatlar genel düzeyi kaynaklı şoklar, ülke risk priminde artışa neden olurken kısa dönemde bağımsız değişkenlerden ülke risk primi üzerine çeşitli gecikmelerden anlamlı etkiler belirlenmiştir. ARDL modelinde kısa dönem sonuçları ile hesaplanan ECM’ye göre bir önceki dönemde oluşan şokun neden olduğu dengesizliğin %26’lik kısmı cari dönemde giderilerek uzun dönemli denge konumuna ulaşılmaktadır.

Retracted: Can Limits to Arbitrage Explain Stock Price Idiosyncratic Volatility Premium Puzzle in China’s A-Share Market?

Retracted: Can Limits to Arbitrage Explain Stock Price Idiosyncratic Volatility Premium Puzzle in China’s A-Share Market?

Dissecting the idiosyncratic volatility puzzle: A fundamental analysis approach

This paper argues fundamental information help resolve information uncertainty that leads to high idiosyncratic volatility premium. The IVOL-return relation is negative for stocks with poor fundamental strength but positive for stocks with strong fundamental strength. The arrival of fundamental news weakens the negative IVOL effect. Our findings are robust for alternative model specifications. Moreover, the negative IVOL effect dominates the positive IVOL effect due to arbitrage asymmetry that buying is easier than short selling stocks. Consistent with arbitrage asymmetry, the negative IVOL effect is stronger for stocks with low institutional ownership and following high investor sentiment. Overall, we provide a simple fundamental-based explanation for idiosyncratic volatility puzzle.

The nexus among maxing out effect and idiosyncratic volatility premium puzzle in China’s A Share Market under the background of eco-innovation and sustainability

The paper investigates whether eco-innovation, sustainability, and asset pricing effect of maximum daily return (maxing out effect), truly and steadily exists in A share market of China and the nexus among maxing out effect and idiosyncratic volatility in China’s A Share Market. Regression analyses were conducted using the data of listed companies in China’s A share market from July 1993 to May 2021. The empirical results show that the maxing out effect, eco-innovation and sustainability steadily exists in a sample country. In practice, this research help to improve asset pricing efficiency, provide high-quality materials for investor education, guide arbitrage trading activities, and improve resource allocation efficiency in the stock market.

Consumption risks in option returns

We offer evidence that exposures to consumption growth and consumption volatility are significantly priced in the cross-section of delta-hedged option returns. Consumption growth commands a positive risk premium, whereas consumption volatility commands a negative risk premium. Our results suggest that consumption risk exposures provide rational foundations for well-known relations between options moneyness or idiosyncratic underlying-stock volatility and the cross-section of delta-hedged option returns. Furthermore, those risk premiums can also price stocks. In a representative-agent economy with recursive preferences, our results suggest that investors prefer early resolution of uncertainty. • Exposures to consumption growth and volatility are priced in option returns. • Consumption risk exposures explain well-known relations in the option market. • Consumption growth and volatility premiums are positive and negative respectively. • Option consumption risk premiums can also price stocks. • Empirical results show that investors prefer early resolution of uncertainty.

Comparing cryptocurrencies and gold - a system-GARCH-approach

This article investigates similarities and differences between gold and four cryptocurrencies (Bitcoin, Ethereum, Bitcoin Cash and Litecoin) with respect to four determinants. To do so, we estimate a system-GARCH-in-mean for the period starting 7/18/2014 at earliest until 7/12/2021. We find that, first, liquidity premia are almost always insignificant for both gold and cryptocurrencies. Second, volatility premia exist in either gold and cryptocurrencies. Third, the response of cryptocurrencies to exchange rate changes is more pronounced than for gold at least if developing countries are included. Fourth, gold exhibits a safe haven status, while cryptocurrencies do not. So according to our results those cannot be seen as a store of value but rather should be seen as speculative assets.

Sector Option Correlation Premiums and Predictable Changes in Implied Volatility

We examine options listed on sector ETFs that constitute the S&P 500 and find evidence of predictability in implied volatilities associated with abnormally high or low implied correlations. We show that sector-implied volatilities evolve to maintain stable relations between sector correlation premiums and the correlation premium on the S&P 500, allowing the calculation of a sector-specific, idiosyncratic correlation premium. The sector-specific correlation premium is a more reliable signal of future changes in sector-implied volatility relative to simple level measures of the volatility or correlation premiums due to its focus on correlation rather than volatility, and its adjustment for aggregate levels. Moreover, we find that one-day reversals in sector-implied volatilities are related only to reversals in the sector-specific correlation premium, and that information extracted from stock-implied volatilities has little or no predictive ability for sector-implied volatility. The predictable variation in sector-implied volatilities associated with the sector-specific component of the correlation premium forms the basis for profitable trading signals that dominate strategies based directly on sector volatility premiums.

Does betting against beta strategy work in major Asian Markets?

This study examines the betting against beta (BAB) anomaly and its drivers for five major Asian markets, using data from January 1999 to January 2020. We find positive raw returns-based BAB premiums for India, China, and South Korea, while they are negative in Japan and Indonesia. Cross-sectional differences in BAB premiums seem to be positively associated with the level of information uncertainty and financial market development. Decomposition of the BAB phenomenon shows that BAB premiums are driven by betting against correlation (BAC) premiums in India while betting against volatility (BAV) premiums drive it in China and S.Korea. Funding liquidity risk and margin constraints drive positive BAC in India and Indonesia. Positive BAV in China is driven by MAX (lottery behavior), while idiosyncratic volatility (IVOL) and MAX together drive them in S.Korea. Negative BAB in Japan and Indonesia is mainly due to negative BAV premiums caused by MAX in Japan and both IVOL and MAX in Indonesia. CAPM-based risk-adjusted BAB premiums are not significant for S.Korea, Japan, and Indonesia, while in India and China, they are significant but get explained by the profitability factor. We conclude that the BAB strategy is not universally applicable, and its drivers vary across sample markets.

Investor Sentiment and Stock Market Returns: Evidence from the Indian Market

Investor sentiment refers to investors' confidence in the market based on their subjective beliefs. Investor sentiment has become a topic of substantial interest among academicians as investor sentiment induces uninformed demand shocks, which can potentially drive away stock prices from their fundamental value. This study expands the literature on the effect of investor sentiment on stock market returns by constructing an Investor sentiment index for the Indian market. We use Nifty-Fifty returns and the sample period ranges from April 2012 to March 2022. The Principal Component Technique is employed to construct an investor sentiment index using seven market and firm implicit proxies: advances to decline ratio, buy-sell imbalance ratio, equity issues to total issues, volatility premium, share turnover, price-earnings ratio, and turnover volatility ratio. The regression analysis shows that the investor sentiment index has the predictive power to forecast Nifty-Fifty returns.

The Moderating Effect of Market-Specific Factors on the Return Predictability of Investor Sentiment

This paper examines the return predictability of investor sentiment in 12 Asian and European markets during the period between 2004 and 2016. Employing the composite sentiment index constructed from the consumer confidence index ( CCI), advance/decline ratio ( ADR), and volatility premium ( VP), we find a strong negative relationship between investor sentiment and the next 3 to 24-month returns. This outcome implies that sentiment could be a contrarian predictor of market returns over various periods. Moreover, we reveal an essential role of local factors, including financial development, institutional governance, and culture, in the sentiment-return diversification among regional markets. We discover that the moderating effect of market-specific factors is time-varying and different between Asian and European areas. As a result, sentiment has a shorter-term impact in Europe but a longer-term impact in Asia.

Asset pricing with free entry and exit of firms

We study the asset-pricing implications of changes in the variety of consumption goods which happens through free entry and exit of firms. Fluctuations in varieties drive a wedge between the measured and model-based (including variety growth) consumer price index making the pricing kernel as well as asset prices more volatile without driving up the volatility of consumption growth. Different from earlier endowment economy models of variety growth our model contains production which (i) generates the correlations important for the explanation of the high mean and volatility of equity premium endogenously, and (ii) leads to an increase of about 140 basis points in the risk-premia relative to the endowment model.

The dynamics of money velocity

ABSTRACT The dynamic of money velocity has changed gradually, influencing how macroeconomic shocks affect money velocity. This paper examines the response of money velocity to the external shocks in a system of equations, where money velocity, real output growth, money growth volatility, expected inflation, and risk premium are jointly determined. The regime-switching behaviour of money velocity is then examined through a Bayesian threshold approach. The main finding suggests that money velocity drops significantly after negative output and expected inflation shocks, followed by a sudden increase. In addition, the regime-switching process distinguishes the deterministic and stochastic behaviour of money velocity.

Decomposing the idiosyncratic volatility anomaly among euro area stocks

We estimate the widely documented idiosyncratic volatility premium at a statistically and economically significant −7.27 basis points monthly among euro area stocks. Furthermore, we test the robustness of Hou and Loh (2016; HL) US findings on the decomposition of the premium in fractions related to lottery characteristics and market frictions. In line with HL, we are able to explain approximately 30% of the anomaly with a balanced contribution between the two competing explanations. The bid–ask spread plays a large role in explaining the anomaly in the euro area, while HL find no consistent evidence for its importance in the US.

The pricing of volatility risk in the US equity market

We analyze whether the pricing of volatility risk depends on the asset pricing framework applied in the tests, the specified volatility proxies, and the portfolio sorts used for spanning the asset universe. For this purpose, we compare the results using a macroeconomic and fundamental based asset pricing model using three proxies of volatility and uncertainty, using size/value sorted and industry sector portfolios. Our results reveal that the marginal pricing effect of the VIX volatility factor is strong and statistically significant throughout the models and specifications, while the effect of an EGARCH-based volatility factor is mixed, mostly smaller but with the correct sign. In most cases, the EGARCH factor does not impair the pricing effect of the VIX. The portfolio sorts have a substantial impact on the volatility premiums in both model frameworks. The size of the volatility risk premium is more uniform across the models if the industry sector portfolio sort is used. Finally, the size/value portfolio sort generates larger volatility risk premiums for both models.

Can Limits to Arbitrage Explain Stock Price Idiosyncratic Volatility Premium Puzzle in China’s A-Share Market?

Investigating the existence and causes of idiosyncratic volatility premium puzzle in developing stock market can enrich the research on this asset pricing puzzle. To investigate the existence and whether limits to arbitrage in China’s A-share market can explain the idiosyncratic volatility premium puzzle, this paper uses listed stocks in China’s A-share market from 2002 to 2019 as a sample. We calculate three individual measures and one comprehensive measure of limits to arbitrage based on Chinese specific regulations. After that, we conduct univariate portfolios analysis, regression analysis, and bivariate portfolios analysis to obtain evidence. We prove that idiosyncratic volatility premium puzzle exists in China’s A-share market and is robust and that limits to arbitrage in this market can partly explain this asset pricing puzzle. This paper enriches research on asset pricing anomaly and can help us evaluate the effect of China’s A-share market reform.

Capital controls and the volatility of the renminbi covered interest deviation

AbstractThis paper examines how capital controls affect the volatility of the renminbi (RMB) covered interest deviation (CID). We find that capital controls amplify the volatility of RMB CID and the amplification effect becomes more prominent in more flexible RMB exchange regimes. Capital controls influence the volatility of interest rate differential (IRD) and forward premium (FP), two components of CID, differently, particularly during the U.S. Fed's QE era. In addition, using an error correction model, we show that, while capital controls magnify both the short‐ and long‐run volatility of the CID and the IRD, they do not affect FP volatility.

Behavioural heterogeneity and equity premium volatility in China

ABSTRACT This paper develops a simple heterogeneous agents model with fundamentalists and chartists. It examines whether investors’ behavioural heterogeneity is related to excess volatility of equity premium in the Chinese stock market. To calculate deviations between the realized and expected values of the equity premium, we use consumption growth model and dividend growth model to estimate the expected equity premiums of CSI 300 from January 2005 to December 2019. After estimating the heterogeneous agents model using the CSI 300 monthly data, we find that investors’ heterogeneity in price trends and trading strategies can significantly explain excess volatility of equity premium. Our analysis of two significant fluctuations, specifically the booms and busts of 2007–2008 and 2014–2015, further corroborates our key finding that investors’ behavioural heterogeneity plays an important role in explaining excess volatility of equity premium.

Linking the performance of vanilla options to the volatility premium

The advent of quantitative investing has made it increasingly important to understand the performance drivers of systematic strategies that use derivatives, such as those based on the sale of options. In this paper we introduce a new formulaic representation to analyse the performance of delta-hedged vanilla options and use this formula to break down the historical performance of foreign exchange straddles held to maturity. We show how, as is widely assumed, the performance is dictated in part by the so-called volatility premium, but also that another important driver is at play, the covariance between the convexity of the option and the prevailing volatility regime. In particular, we determine empirically that the sign of that driver’s contribution is tenor specific. These results can be used to size directional or relative value option strategies and to disentangle the impact of the various performance drivers in the booming field of systematic options strategies.