Spread Volatility Research Articles

Attention: Implied Volatility Spreads and Stock Returns

Using a new and direct measure of investor attention generated from the SEC’s EDGAR log files, we revisit the stock return predictability of call-put implied volatility spread through the lens of investor attention. We find that as investor attention heightens, the volatility spread return predictability becomes more pronounced, providing favorable evidence for the informed trading hypothesis as opposed to the mispricing hypothesis. More importantly, we document the construction and profitability of spread-and-high-attention portfolios. A portfolio that goes long on stocks with the highest investor attention and the highest volatility spread and short on stocks with the highest attention and the lowest volatility spread generates a Fama-French 5-factor monthly alpha of 2.43%.

Coal Mines Risk Modelling Using Energy Spread

The growing importance of the cost of electricity in coal mining, changes in the value chain in recent years and new commodity exchanges cause that mine operators independently or vertically integrated with power plants have possibility to buy and sell coal and electricity and create a specific spread. The study of risk based on the concept of a new indicator: an intrinsic spread. The intrinsic spread is calculated as a difference between the income from the sale of coal and the cost of purchasing the energy required for the coal production. This indicator shows a market risk in the coal mine in a better way, because except for income it includes a part of the cost of exploitation which can be hedged in the exchange market. Spread calculations were made on historical data and simulation modelling. Based on time series of coal and energy prices for various contracts and spot prices obtained from the EEX the impact of the type of contracts on the volatility of the intrinsic spread in subsequent periods measured by the standard deviation of returns has been analysed. It was found that hedge using futures helps to reduce the risk in the mine. Modelling of coal prices and electricity was carried out by conventional financial market econometric models. The best-fitting econometric models are multivariate models and models based on the copulas. The simulation results show that the use of futures contracts contributes little to reducing the intrinsic spread volatility. An econometric model with the technical and economic parameters of the mine typical for hard coal mine has been built. Changes in fixed and variable costs have been simulated based on triangular distributions. Parameters for simulation were estimated based on the economic data from the mines. Additionally, coal and energy prices were dependent on the market volatility. Based on the economic model and Monte Carlo simulation it has been found that the proposed method may be helpful in reducing the coal mine market risk.

Evaluating sovereign risk spillovers on domestic banks during the European debt crisis

Using a Markov-switching model with time-varying probabilities, spillovers from sovereign to domestic bank CDS spreads during the European debt crisis for a set of 14 European countries and 30 European banks are investigated. Our model is able to capture how the increased sovereign risk observed between 2010 and 2013 throughout Europe has impacted i) the probability that banks fall into a crisis regime and ii) the probability that banks stay in the crisis regime. The latter state is characterized by a high volatility and large positive returns of CDS spreads. Different regime-dependent indicators have been computed to assess heterogeneity within the region. The evidence indicates that the intensification of sovereign risk observed during the European debt crisis has positively and significantly driven the regime shifts in volatility of the bank CDS spreads due to increased risk aversion. The results show that the increase in sovereign credit risk seems to have generated second-round effects for some banks that have experienced a deterioration in their funding conditions due to a rise in the domestic sovereign default risk. Overall, our results suggest that sovereign CDS spreads can be considered good forewarning indicators for predicting the evolution of bank CDS spreads. We also find that the effects differ depending on the country and the financial institution. This result suggests that banks are heterogeneously exposed to sovereign credit risk within the same country. One argument relates to the size of these financial institutions and the domestic exposure to sovereign debt.

The role of audit quality on market consequences of voluntary disclosure

PurposeThe purpose of this paper is to investigate the role of the auditor in enhancing the market consequences of voluntary disclosure in East Asian countries that have different reporting environments. This study also investigates the effect of quality of the reporting environment on the role of the auditor in enhancing market consequences of voluntary disclosure.Design/methodology/approachThe methodology used in this research is multiple regressions using the least square method. This research uses East Asian countries context that covers India, Indonesia, Japan, Malaysia, the Philippines, Singapore and Thailand with cross-sectional data during 2016. This research uses four measurements of market consequences, namely, cumulative abnormal return (CAR), volatility of return, bid-ask spread and trading volume.FindingsThe results show that voluntary disclosure gives positive consequences to the capital market by increasing the CAR, volatility of return and average trading volume, and decreasing asymmetric information. The results also show that auditor plays a significant role in increasing the credibility of voluntary disclosure by increasing the market consequences of disclosure. The role of the auditor in increasing the effect of voluntary disclosure is higher in a country that adopts international best practice in financial reporting.Research limitations/implicationsThe findings of this study need to be interpreted with caution due to several limitations. Although the measurement of voluntary disclosure used in this study is relatively more complete compared to previous research, there are still much voluntary information disclosed that are not included in the checklist. Moreover, this study only considers voluntary disclosure in the annual report. Therefore, future studies can develop a more comprehensive measurement of voluntary disclosure and use sources of information beyond the annual report.Practical implicationsThis study shows that in a reporting environment that is less transparent as in the conditions of countries in East Asia, voluntary disclosure and the role of the auditor in increasing value of voluntary disclosure for market participants is crucial. Companies need to increase their voluntary disclosures as they become additional provisions in improving the reporting environment and consider the result of this study when choosing the auditor. Second, audit quality is more important in increasing the credibility of voluntary disclosure in countries that adopt international best practices in financial reporting. The result of this study implies that audit quality is a complementary mechanism of the reporting environment.Originality/valueThis study expands the literature of the role of the auditor on the market consequences of voluntary disclosures and explores the role of the auditor in different reporting environment across countries in East Asia. This study shows that auditor increases the credibility of voluntary disclosure in the different context of accounting and auditing practices.

The Effects of Ownership Structures on Firm Information Asymmetry in Malaysia

This paper presents the relationship between different types of blockholders with information asymmetry in Malaysian firms. To be more specific, this study divides the ownership structures into managerial blockholder, institutional blockholder and individual blockholder and ownership concentration while holding firm size and trading volume as control variables. On the other hand, the stock volatility and bid-ask spread are used as a proxy for information asymmetry. A sample of the top 150 largest public listed firms in term of market capitalisation is chosen from Bursa Malaysia from 2011 to 2015. Panel regression analysis is used to examine the data. The results show managerial blockholders, firm size and trading volume significantly influence information asymmetry. While institutional blockholders, individual blockholders and ownership concentration exhibit no relationship with information asymmetry. The study from this result can be useful for investors and the policymakers in Malaysia as it gives a clearer picture and more understandings on ownership structures and information asymmetry in the Malaysia market.

Uncertainty in Euro area and the bond spreads

We investigate potential mean and volatility spillovers among sovereign bond yield spreads for five peripheral countries of the euro area. We focus on Greece, Ireland, Italy, Portugal and Spain during the European sovereign debt crisis. We propose a bootstrap bias-corrected bivariate Vector Autoregressive Moving Average (VARMA), GARCH-in-Mean, asymmetric BEKK model, and find that the level and the volatility of a bond yield spread are mainly dependent on its own past volatility, and thus, its past shocks mainly affect its volatility. Based on our findings, we suggest that the number one priority of the European policymakers be the economic and financial integration of the European peripheral countries into the core.

KOSPI200 지수옵션 변동성스프레드의 결정요인

KOSPI200 지수옵션 변동성스프레드의 결정요인

The Sarbanes‐Oxley act and informed trading in the options market: Evidence from share repurchase announcements

AbstractThis study examines the informed options trading hypothesis before and after the implementation of the Sarbanes‐Oxley Act (SOX). We find that informed option trading, as measured by implied volatility spreads, occurs only in the period before the enactment of this Act but disappears thereafter. Our results suggest that the SOX had a significant impact on informed trading in U.S. option markets.

Information Embedded in Option Prices: Evidence from Credit Rating Agency Announcements

We employ the implied volatility spread (IVS) and the short lending fee as measures of private information conveyed by their respective markets. Using credit rating announcements as an informational event, we find that both IVS and the short fee have significantly higher predictive power for returns on event days versus non-event days. Both IVS and the short fee also predict the direction and magnitude of credit rating changes. Options order imbalance (OIB) does not explain the results. In models with both explanatory variables, the short fee remains significant in all specifications, while IVS loses explanatory power.

Belief heterogeneity in the option markets and the cross-section of stock returns

• Standard deviations of option risk measures help explain cross-section of returns. • This is robust to the levels, vol-of-vol, and other characteristics and risk factors. • We find support for viewing these measures as proxies for heterogeneous beliefs. • Negative relationship with returns supports ( Miller, 1977 ) overvaluation theory. Standard deviations of the implied-historical volatility spread, of implied volatility innovations, and of the volatility term structure spread in equity options help explain the cross-section of one-month-ahead underlying stock returns. The explanatory power from standard deviations is robust to the levels of these three variables, volatility of volatility, firm characteristics, and common risk factor models. We find support for interpreting the standard deviations of these option-based measures as forward-looking proxies for heterogeneous beliefs. The negative relationship between our three measures and future underlying returns is consistent with the Miller (1977) overvaluation model which implies that divergence of investor opinions in the presence of short-sale constraints leads to lower expected returns.

Price Volatility Spillover in Ship Demolition Markets

World ship demolition activities are mainly carried out in Bangladesh, China, India, Turkey and Pakistan. Conducting in so few countries leads to a high level of competition among countries, as well as being influenced by each other's prices. So, there is no natural situation for each other to follow their prices, and this can be reflected as a flow of information to the variances of the prices. When this information flow exists, volatility spreads can be observed between the prices. In this context, this study aims to determine the flow of information between the major countries operating in the demolition sector in the world by using the causality in variance method. The dataset covers the dates between 8th January 2013 and 24th December 2018 and consist of 309 observations on a weekly basis. According to the results, there are volatility spillovers from Turkish demolition prices to all other country prices except China in terms of both general cargo and tanker ships. In addition, there are volatility spillovers from Pakistani tanker demolition prices to Bangladeshi and Indian prices. These results reveal that the demolition business entities of other countries follow the Turkish prices in determining general and tanker demolition prices, and Pakistani prices only in determining tanker demolition prices. Thus, the volatilities in Turkish and Pakistani prices are reflected in the prices of the other demolition countries. On the other hand, Chinese has a special position since its prices are not affected by the other prices and do not affect the other prices.

Substitution between Short Selling and Options Trading in Predicting Aggregate Stock Returns

Splitting stocks into groups with and without options trading, we find that only the aggregate short interest index constructed by the stocks without options trading predicts market returns in both in-sample and out-of-sample tests. The return predictability is up to six months and does not revert. Similarly, when splitting stocks into groups based on short selling risks, we find only the aggregate option implied volatility spread constructed by the stocks with higher short selling risks predicts market returns. Overall, our results show that there exists a substitution effect between short selling and options trading in predicting aggregate stock returns. This substitution effect could explain the phenomena that aggregate short interest does not predict market returns in recent years, given the rapid development of the options market.

Option-Implied Volatility Measures and Stock Return Predictability

Using firm-level option and stock data, we examine the predictive ability of option-implied volatility measures proposed by previous studies and recommend the best measure using up-to-date data. Portfolio level analysis implies significant non-zero risk-adjusted returns on arbitrage portfolios formed on the call-put implied volatility spread, implied volatility skew, and realized-implied volatility spread. Firm-level cross-sectional regressions show that, the implied volatility skew has the most significant predictive power over various investment horizons. The predictive power persists before and after the 2008 Global Financial Crisis.

Pricing sin stocks: Ethical preference vs. risk aversion

We develop an ethical preference-based model that reproduces the average return and volatility spread between sin and non-sin stocks. Our investors do not necessarily boycott sin companies. Rather, they are open to invest in any company while trading off dividends against ethicalness. When dividends and ethicalness are complementary goods and investors are sufficiently risk averse, the model predicts that the dividend share of sin companies exhibits a positive relation with the future return and volatility spreads. An empirical analysis supports the model’s predictions. Taken together, our results point to the importance of ethical preferences for investors’ portfolio choices and asset prices.

Option Market Signals and the Disposition Effect Around Equity Earnings Announcements

The authors provide evidence that equity traders who miss or ignore signals from the options market have an increased disposition to hold their loser positions following earnings announcements. Postearnings equity returns that (do not) align with pre-earnings options market signals are fast (slow) to return to ordinary levels. We attribute this to the disposition effect arising from overconfident traders. The authors furthermore show an enhanced positive relationship between postearnings equity returns and option-implied volatility spreads when those spreads are driven by deep out-of-the-money options, which we attribute to the existence of private information.

Sovereign Spread Volatility and Banking Sector

Using structural vector autoregression augmented with stochastic volatility (SVAR-SV), we document that in late 2000s there were large spikes in volatility of spreads on peripheral eurozone government bonds. This increased volatility entailed a significant decline in bank credit to nonfinancial sector and real economic activity. We rationalize these results in a New Keynesian dynamic stochastic general equilibrium (DSGE) model with financial intermediation. In our framework, a rise in spread volatility erodes banks’ net worth and constrains their balance sheets. The banks respond by slashing their lending to real sector, dampening the economy as a whole. Results from the model match our empirical findings.

Experiments in high-frequency trading: comparing two market institutions

We implement a laboratory financial market where traders can access costly technology that reduces communication latency with a remote exchange. In this environment, we conduct a market design study on high-frequency trading: we contrast the performance of the newly proposed frequent batch auction (FBA) against the continuous double auction (CDA), which organizes trades in most exchanges worldwide. Our evidence suggests that, relative to the CDA, the FBA exhibits (1) less predatory trading behavior, (2) lower investments in low-latency communication technology, (3) lower transaction costs, and (4) lower volatility in market spreads and liquidity. We also find that transitory shocks in the environment have substantially greater impact on market dynamics in the CDA than in the FBA.

Options trades, short sales and real earnings management

We study the link between measures of stock options’ volatility and firms’ real earnings management (RM). We hypothesise that RM causes uncertainty in the value of a firm’s common stock and, as a result, increases the volatility spread and skew of the firm’s options. Spread and skew proxy for investors’ uncertainty in the value of the options underlying a stock. Consistent with our hypothesis, we find an association between a firm’s use of RM, and the volatility spread and skew in the firm’s options, more precisely in its put options. We also study the link between short selling and the extent of RM but do not find a consistent relationship between the two.

Basis Risk When Hedging a Global Credit Portfolio

We examine the efficiency of hedging a credit derivative portfolio with a contrary position in a credit index in the face of decreased correlations between single name CDSs and credit indices. The interest of such hedge comes from the fact that the calculation of the capital charge for CVA risk, as required by the Basel Committee on Banking Supervision, is usually rather unstable due to the volatility of CDS spreads. Since credit derivatives on single names are not very liquid, the implied adjustments in capital charges could be reduced by the mentioned hedging strategy, and we show that there is enough diversification of risk in a global credit portfolio to allow for a good hedge. Over the whole sample, the reduction in the variance of the portfolio’s profit and losses (P&L) is of 80% for a European portfolio, 60% for North American and Japanese portfolios, and around 70% for a global portfolio. Using a strategy that takes into account the quality of the credit counterpart improves the effectiveness of the hedge, although it requires using less liquid credit indices, with higher transaction costs. Standard conditional volatility models provide the same results as a least squares hedge. The efficiency of the hedge for a credit portfolio made up of the most idiosyncratic firms seems to require more than 50 firms, while the hedge for portfolios made up of the less idiosyncratic firms achieves high efficiency even for a small number of firms. The efficiency of the hedge is higher when portfolio volatility is high and also when short term interest rates or exchange rate volatility are high. Increases in VIX, in the 10-year swap rate or in liquidity risk tend to decrease hedging efficiency.

Multi-Curve Cheyette-Style Models with Lower Bounds on Tenor Basis Spreads

The modeling of tenor basis spreads is of central importance to CVA for tenor basis swaps. Such spreads are typically positive, suggesting a natural lower bound. We introduce a multi- curve Cheyette-style model with lower bounds enforced through level dependence in spread volatilities. The model is intuitive, easy to implement, and admits approximate swaption pricing formulae under affine specifications. We also discuss the importance of incorporating historical spread data into calibration criteria, and we formalize an according calibration strategy.