Spread Volatility Research Articles

Volatility Spillover Between Bitcoin And Financial Stress Index

Purpose: This paper aims to test the volatility models for Bitcoin (BTC) and the financial stress index (FSI) and examine the volatility spillover among them. This aim was reached by obtaining weekly data from the 7th of January 2011 and the 24th of December 2021. Methodology: First, volatility modelling for the series is provided, and GARCH (1,1) for the BTC series and IGARC (1,2) for the FSI series are determined as the most appropriate volatility models. Then, residual volatility series are created for each variable over the IGARCH (1,2) and GARCH (1,1) models for the volatility spread between the series. The volatility spread between the series is examined with the diagonal VECH GARCH method. It is concluded that there is a positive volatility spillover effect from the FSI variable to the BTC variable. Then, impulse-response analysis is performed on the volatility residual series created for each variable. The empirical findings from impulse response analysis support a risk transfer between BTC and FSI series. Results and Findings: Changes in the BTC return series and FSI series are caused mainly by themselves, and the series are most affected by their shocks. By comparing the variance decomposition of the volatility series with the analysis results, it can be said that the changes in the volatility series are caused mainly by each other.

Return Volatility Spread in Commodity Volatility Indices: Spot and Future Market Research

Volatility Indices are an important indicator for investors to accurately predict returns and risks in case of uncertainty in the markets. In this study, the effects of the gold, silver, and oil volatility indices (GVI, SVI and OVI) on the returns and volatility of both spot and futures assets were investigated using the VAR-EGARCH procedure. The findings of the study reveal that both the GVI and gold futures prices have a positive effect on gold spot prices. At the same time, it has been determined that gold futures prices are obtained from the GVI and gold spot prices. On the other hand, although SVI and future prices were effective on silver spot prices, only SVI lagged prices were effective on silver futures. Finally, OVI and oil future returns were ineffective on oil spot prices, and only OVI returns were effective on oil future prices.

Permanent and Transitory Components of Volatility following the 2008-Financial Crisis: Investigation on Dow Jones Sukuk Index

The global financial crisis of 2008 was sukuk's first actual test. The crisis had a negative impact on the nascent sukuk market, and several issuances reached new lows during the crisis. The sukuk investment universe, on the other hand, has made a strong comeback since 2009 and is now fully recovered. The sukuk market's performance has proven to be resilient due to this. The Dow Jones Sukuk Index (DJSI) has fully recovered from the crisis after a period of underperformance. The performance of the sukuk index is judged on both return and risk. Lower volatility and a higher Sharpe ratio further enhance its superior performance. The Sukuk investors during the COVID-19 pandemic have also referred to this situation of the 2008 global financial crisis to seek chances and confidence to issue and invest in Islamic bonds (Rahim and Othman, 2021). According to Ghassan, Balli and Aljeefri (2021), a crisis has little impact on the volatility of sukuk spreads. The result is due to market participants' belief in sukuk as an important asset class in their investment portfolios. This research aims to address this problem. Keywords: Financial crisis, Sukuk, CGARCH, components, DJSI

Implied Volatility Spread and Stock Mispricing

Stocks can be mispriced for at least two reasons: value-relevant information is not timely incorporated or investor sentiment can induce mispricing. Using the mispricing measure proposed by Stambaugh, Yu, and Yuan (2015), we show that informed trading in the options market, proxied by the implied volatility spread, can substantially alleviate stock mispricing. Higher implied volatility spread reliably predicts subsequently lower stock mispricing after controlling for an array of economic variables including firm size, illiquidity, idiosyncratic volatility, institutional ownership, and investor’s divergence of opinions. In addition, this effect is more pronounced when the options trading volume is higher, consistent with the notion that higher options trading volume provides better camouflage for informed trading in the spirit of Kyle (1985). Our findings highlight the importance of information incorporation to reduce asset mispricing. We further show that a self-financing monthly portfolio that goes long on most underpriced stocks and short on most overpriced stocks when the implied volatility spread is the lowest yields statistically and economically significant abnormal returns.

Informed options trading prior to FDA announcements

AbstractWe find that pre‐announcement implied volatility spreads and options trading activity are abnormally elevated and can predict Food and Drug Administration (FDA) announcement date stock returns. The effect is more pronounced in firms with higher levels of information asymmetry and lower‐quality corporate governance suggesting that some options traders are informed in advance of the details that affect the stock price impact of the FDA news. We provide the first examination of informed options trading prior to FDA announcements during a 21‐year period. Our findings have implications for regulators, investors and relevant firms.

Self-Fulfilling Debt Crises, Revisited

Lack of commitment at the time of auction to repayment of imminently maturing debt can generate a run on debt and immediate default. We show that the same lack of commitment leads to other possible self-fulfilling crises, including issuance of more debt at depressed prices, or a “sudden stop” (forced austerity) in which debt issuance is sharply curtailed. Both outcomes stem from the government's incentive to eliminate uncertainty about imminent payments at the time of auction by altering the level of debt issuance. These outcomes generate a large increase in spread volatility in both a 1-period and a multiperiod quantitative debt model.

Estimating actual probability of default from structural models

In this paper, we study the probability of default, the credit default swap (CDS) implied probability of default, and the estimated actual probability of default from the structural models. We first show that the conditional risk-neutral probability of default is totally different from the CDS implied probability of default, and the CDS implied probability of default provides biased estimation of a corporation’s actual probability of default. Hence, the common belief that the CDS implied probability of default gives unbiased (or reliable) estimations of the firm’s probability of default is false. Furthermore, we use the credit spread risk premium as the difference of the physical measure and the risk-neutral measure of the credit spread to estimate the actual bond spread, and relate the credit spread risk premium in terms of the market price of risk and the credit spread volatility. Using the credit spread volatility and the risk-neutral credit spread and the market price of risk in hybrid HPD model, we obtain the estimated actual probability of default in a structural model. The estimated actual probability of default would be useful for credit rating agencies, investors, credit risk managers and regulators.

Extreme risk spillovers from commodity indexes to sovereign CDS spreads of commodity dependent countries: A VAR quantile analysis

Given the financialization of commodities and the increase in the CDS markets' size and structure, we examine the co-movement and dependence structure between four commodity indexes and sovereign credit risk via an extreme volatility risk spillover methodology. We use the daily change in sovereign CDS data between October 1, 2010 to March 31, 2020 for ten commodity-dependent countries and four commodity indexes (agricultural, precious and industrial metals, and energy). The results of White et al.'s (2015) VAR for Value at Risk (VaR) and the pseudo quantile impulse response function (QIRF) show that the volatility of the primary commodity export category (e.g., agriculture, mineral, and energy) substantially influences the volatility of sovereign spreads (except for two agriculture-dependent exporters). Still, it does not always have the strongest risk spillover effect when other commodity indixes are included in the analysis. When drilling down on the data and examining the single commodity index (i.e., gold, corn, etc.), our results indicate that the primary commodity exports significantly influence the volatility of its sovereign CDS spreads. Based on the results of the QIRF, most shocks are absorbed within 30 days. Most risk spillover from the volatility of sovereign CDS spreads to the volatility of commodity indexes is found to be insignificant.

The meaning of structural breaks for risk management: new evidence, mechanisms, and innovative views for the post-COVID-19 era

<abstract> <p>This paper quantitatively reveals the meaning of structural breaks for risk management by analyzing US and major European banking sector stocks. Applying newly extended Glosten-Jagannathan-Runkle generalized autoregressive conditional heteroscedasticity models, we supply the following new evidence. First, we find that incorporating structural breaks is always effective in estimating banking stock volatilities. Second, we clarify that structural breaks partially explain the tail fatness of banking stock returns. Third, we find that when incorporating structural breaks, the estimated volatilities more accurately capture their downside risk, proving that structural breaks matter for risk management. Fourth, our news impact curve and model parameter analyses also uncover that when incorporating structural breaks, the asymmetry in volatility responses to return shocks is more accurately captured. This proves why the estimated volatilities by incorporating structural breaks better explain downside risk. In addition, we further reveal that the estimated volatilities obtained through incorporating structural breaks increase sharply during momentous events such as the Lehman crisis, the European debt crisis, Brexit, and the recent COVID-19 crisis. Moreover, we also clarify that the volatility spreads between models with and without structural breaks rise during the Lehman and COVID-19 crises. Finally, based on our findings, we derive many significant and beneficial interpretations, implications, and innovative views for risk management using artificial intelligence in the post-COVID-19 era.</p> </abstract>

The Financial Accelerator, Wages, and Optimal Monetary Policy

This paper studies the effects of labor market outcomes on firms’ loan demand and on credit intermediation. In a first step, I investigate how wages in the production sector affect bank net worth and the process of financial intermediation in partial equilibrium. Second, the role of the identified channels are studied in general equilibrium using a new- Keynesian DSGE-model with financial frictions and an endogenous financial accelerator mechanism. Third, I investigate how perfect and imperfect labor markets, in a setting with interactions between production factor costs and the intermediation of credit, affect the transmission mechanism of monetary policy. The analysis reveals that financial frictions reduce the factor demand elasticity of capital to a change in wages. This finding is relevant for the determination of optimal monetary policy, both for financial shocks and supply shocks inflation stabilization imposes high welfare costs. At the same time, stabilizing nominal wages becomes welfare beneficial by reducing both the volatility of the credit spread and the output gap.

Variation in option implied volatility spread and future stock returns

A consistent theme in the finance literature is that implied volatility measures have predictive power for future stock returns and thus reflect investor beliefs about future stock valuations. We use the variability of option implied volatility spread as a proxy for the impounding of new information, and changes in the interpretation of existing information, into option prices. Over the 2006–2016 period, we find that the predictive power of option implied volatility spread for future stock returns is significantly greater when implied volatility spread has been more variable in the past. Our results are statistically and economically significant and robust in both univariate and multivariate settings. Overall, our findings suggest a portfolio strategy using the conjunction of both the level and variability of the implied volatility spread results in significantly better portfolio performance than using the level alone.

Sovereign risk matters: Endogenous default risk and the time-varying volatility of interest rate spreads

Emerging markets’ interest rate spreads display substantial time-varying volatility. We show that models with endogenous sovereign default risk à la Eaton and Gersovitz (1981) can account for such volatility, even in the absence of shocks to the second moments of the exogenous stochastic variables. In particular, these models feature a key non-linearity that allows them to replicate the stochastic volatility of interest rate spreads and its comovement with other important economic variables. Volatility correlates positively with the level of the spreads and the trade balance, negatively with output and consumption. Hence, sovereign default models endogenize the stochastic volatility of interest rates observed in emerging market economies.

Can the Implied Information of Options Predict the Liquidity of Stock Market? A Data-Driven Research Based on SSE 50ETF Options

Liquidity reflects the quality of the market. When the market is short of liquidity, it often causes investors’ trading difficulties and stock price volatility, expanding the investment risk. As a risk management tool, options attract more informed investors to trade because of their flexible design. To explore whether the implied information based on the formation of option price can predict the liquidity of stock market, we take SSE 50ETF options from February 9, 2015, to December 31, 2020, as the research sample. Based on the idea of data-driven approach, we extract the implied information contained in option price, including implied volatility, implied volatility spread, and variance risk premium. Through the regression analysis method, we examine the ability to predict the liquidity of the stock market. The results show that implied volatility spread has the strongest ability to predict the liquidity of the stock market, and it is more significant within 270 days. Implied volatility contains the information about the short-term (120 days) liquidity of the stock market in the future. It shows that implied volatility and implied volatility spread are good indicators to predict stock market liquidity. In contrast, variance risk premium cannot predict the liquidity of stock market. The research conclusion verifies the role of option-implied information in predicting the stock market’s liquidity. By extracting the information of options price, investors and financial regulators can scientifically participate in the financial market under data guidance.

An Analysis of the Stock Market Volatility Spread in Emerging Countries

This article provides results on the volatility spread for stock markets in emerging economies. Empirical studies on determining or predicting volatility in national and international financial markets provide information for investors. The aim of this study is also to analyze volatility spreads from the United States of America, France, Germany, Japan Turkey, China, India, Indonesia from emerging markets within the scope of EGARCH models, which take into account the asymmetric effects using daily stock returns for the period of January 2008 - April 2020. The a symmetric effect parameter (λ or µt-i/ht-1) appears to be negative and statistically significant at 1% for all countries, except the Shanghai Composite Stock Exchange, China. This result shows that the asymmetric effect, or the leverage effect in other words, is valid in stock markets other than China. The volatility spreads from the Dow Jones Industrial Average Index – USA to Borsa Istanbul and the Shanghai Stock Exchange – China. Also, the S & P 500 Index – USA is significant on the volatility spread of the Borsa Istanbul and Shanghai Stock Exchange. The volatility spread between Jakarta Stock Exchange - Indonesia and Borsa Istanbul is two-way and mutual. 

Volatility models for cryptocurrencies and applications in the options market

We investigate the effectiveness of various volatility models using the Bitcoin (BTC) and Ethereum (ETH) price series. Amongst the single-variate models, the GARCH model performs well both in sample and out of sample. Moreover, we do not observe any significant asymmetric volatility reponse to past returns in the GJR-GARCH model. Although the multi-variate VARMA-DCC-AGARCH model outperforms in sample, it performs worse out of sample than the single-variate GARCH model. Furthermore, the GARCH volatility forecast outperforms the option implied volatility in forecasting future realized volatility. We formulate an option trading strategy by exploiting the volatility spread between the GARCH volatility forecast and the option implied volatility. We show that a simple volatility-spread trading strategy with delta-hedging can yield robust profits for both BTC and ETH options. We interpret the strategy profitability as evidence for the pricing inefficiencies in the cryptocurrency options market during our sample period.

Turizm Endeks Getirileri Arasındaki Oynaklık Geçişkenliği: BIST Turizm Endeksi ve Bazı Avrupa Ülkeleri Turizm Endeksleri Uygulaması

Turkey is one of the important countries in Europe in terms of tourism sector. In Turkey, which is in competition with the European Union countries Italy, Spain and Greece in terms of the tourism sector, the volatility of the volatility of the tourism sector stock indices in this competitive environment is also an important situation. The aim of this study is to reveal the effects of volatility of Spain tourism index BCNR.BC, Italy tourism index FTITLMS and Greece tourism index FTATTRA on Turkish tourism index volatility. In the study, the volatility spread between variables was analyzed using the daily return series between 19.06.2015-19.06.2020 with the BEKK-GARCH model. According to the empirical findings obtained, a bidirectional volatility spread from the BIST tourism index to the BIST tourism index, from the FTATTRA index to theFTATTRA index, was found. In addition, there is a one-way volatility interaction from the FTITLMS and BCNRBC indices to the BIST tourism index. No volatility interaction was found from BIST tourism index to FTITLMS and BCNRBC indices.

New Continuum of High Volatile Currency Spillover During EU-BREXIT

In this study, the researchers observed the impact of Brexit on the Pound and its spillover to other European countries, likely to be affected during that period. The intraday high-frequency hourly return data of chief monies as Great Britain Pound (GBP), Euro (EUR), Danish Krone (DDK), Hungarian Forint (HUF), Turkish Lira (TRY), Swiss Franc (CHF), Swedish Krona (SEK), and Polish Zloty (PLN), for two months and one day, was utilized. The Intraday volatility spillover index approach and a further rolling window technique applied. The analysis of high-frequency data revealed that four currency pairs as TRY/USD, DKK/USD, PLN/USD, and HUF/USD, are highly volatile currencies. However, three pair currencies as GBP/USD, EUR/USD, and SEK/USD, are comparatively lesser volatile. The results and managerial implications reflect preparedness dynamics and proactiveness for a new continuum project that regional transmission effects of volatility spread from one currency to other currencies in the EU during Brexit.

Optimal Loan Loss Provisions and Welfare

We study the welfare implications of optimal loan loss provisions in a New Keynesian model featuring endogenous default risk and inflationary credit spreads. A unique link between provisions, credit spreads and inflation can be employed to enhance macroeconomic stability. Optimal provisions are most effective when dealing with cost-push financial shocks inherent in volatile spreads and the zero bound problem of monetary policy. Relaxing provisioning requirements following a recessionary financial disturbance consistently achieves the first-best outcome while nullifying the value of monetary policy under commitment. In contrast, deflationary demand shocks warrant an optimal rise in provisions, which inflate prices yet mildly contract output.

Investor sentiment, misreaction, and the skewness‐return relationship

AbstractThis study examines the effect of investor sentiment on misreaction and explores the time‐series relationship between risk‐neutral skewness (RNS) and subsequent stock market returns contingent on sentiment‐induced overreaction. Using the adjusted put‐call implied volatility spread as a misreaction proxy and Bakshi et al.'s method to measure RNS, we find that pessimism leads to overreaction. This overreaction could strengthen the negative RNS‐return relationship, with higher market returns following lower RNS. Our results are robust even after excluding the sample period of the 2008 financial crisis, profiting from market‐timing strategies based on the levels of RNS and overreaction, and using an alternative RNS measure.

ECB's unconventional monetary policy and spillover effects between sovereign and bank credit risk

PurposeThe paper examines the impact of the deteriorating fiscal conditions of Eurozone countries on spillover effects on bank credit margins. It is investigated whether these effects have been reduced after European Central Bank’s (ECB) signaling of pursuing an expansionary, unconventional, monetary policy to address the debt crisis in Eurozone.Design/methodology/approachA general econometric panel model is applied to investigate spillover effects between Eurozone countries and bank credit margins. In total, three periods are examined: the period before the peak of the global financial crisis and the beginning of the Irish banking crisis, the period during the debt and bank crisis in Eurozone and the period after ECB's signaling of extremely aggressive monetary easing.FindingsAccording to empirical results, before the peak of the global financial crisis there was no substantial credit risk transfer from Eurozone sovereigns to banks. During the period of debt and bank crisis in Eurozone, the deterioration of the fiscal situation of Eurozone countries had a significant impact on bank Credit Default Swap (CDS) spreads. After ECB's signaling of extremely aggressive monetary easing, it does not seem to be any significant relationship between Eurozone sovereigns and bank CDS spreads. These findings reinforce the assessment that ECB's measures were effective, achieving the key objective of normalizing economic conditions and ensuring financial stability in Eurozone.Research limitations/implicationsA question is whether effects can change when the corresponding contraction will lead to a reinstatement of “normal” conditions. Would there be a reversal of risk premium trends in bond markets? Although the answer from casual observations seems to be negative, it is a valid research question to be examined. An interesting issue concerning the unconventional monetary policy measures implemented by ECB concerns the issues of moral hazard that they incorporate, something that could not be addressed. Another research perspective could be the use of the beta coefficient to measure the systematic and unsystematic risk of banking sector shares.Practical implicationsThe results have strong implications for ECB and European banking regulation. Regulators should mainly pay more attention to the amount and concentration of sovereign debt held by banks. Eurozone financial system could be less vulnerable to the sovereign credit risk. It raised the critical question of whether a more strict regulation is needed. Regulators should not intervene if not necessary, but they must prevent the transmission of crises between markets. This will likely bring trust to the developed countries' sovereign debt and the portfolios of the financial institutions, which hold most of this debt will be considered safe as well.Social implicationsThe conclusions provide a safe counterweight in various respects. First, the negative effects and the need to rapidly cease or limit such policies. Second, the financial stability aimed by ECB. Such policies contain the possibility of a subsequent moral hazard related to Member State and bank behavior. However, these contingencies need to be assessed with the benefits resulting from the restoration of financial markets and the disconnection between banking and sovereign credit risk. This leads Eurozone's financial system to become less vulnerable to the sovereign credit risk and therefore more safe, helping to restore confidence in the real economy.Originality/valueContribution in terms of methodology and conclusions. It offers important conclusions regarding the limitations of yields and volatility of CDS spreads. It examines the spillover effects of the fiscal situation of Eurozone countries on banking institutions by extending the existing methodology and introducing new questions focusing on the reaction of CDS market to the ECB monetary policy, the reduction of risk premiums at sovereign and banking level and the gradual reduction of interdependence between them.