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Leverage Effect, Volatility Feedback, and Self-Exciting Market Disruptions

25 Oct 2011

Article by: Peter Carr, Liuren Wu
Published by: Presentation at Baruch College
Date: 30 Mar 2009

Disentangling the Multi-dimensional Variations in S&P 500 Index Options

“The equity index and index volatility interact through several distinct channels. First, holding business risk fixed, an increase in the level of financial leverage raises the level of the equity volatility. Second, regardless of the level of financial leverage, a positive shock to business risk increases the cost of capital and reduces the valuation of future cash flows, generating an instantaneous negative correlation between asset returns and asset volatility. Finally, the market experiences both small continuous movements and large market disruptions. The large and negative market disruptions often generate self-exciting behaviors. The occurrence of one disruption induces more disruptions to follow, thus raising market volatility. We propose an equity index dynamics that capture all three channels of interactions through the separate modeling of the asset return dynamics and the financial leverage variation. We analyze how the different sources of variations impact the index options behaviors differently across a wide range of strikes, maturities, and calendar days.”

Full article (PDF presentation): Link

 
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Posted in Implied volatility

 

Volatility as an Asset Class

24 Oct 2011

Article by: Robert Huebscher
Published by: Advisor Perspectives
Date: 3 Feb 2009

“The concept of volatility as an asset class is the latest result of the never-ending quest to create products for consumption by the investor community. But while volatility might serve a useful purpose as a measure of investor sentiment, it is only a true asset class for the marketing purposes of Wall Street’s financial engineers.”

Full article (PDF): Link

 
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Posted in Implied volatility

 

A VIX-ing Paradox

17 Oct 2011

Article by: Lawrence G. McMillan
Published by: Barrons
Date: 5 Oct 2011

“Traders of volatility derivatives — futures, options, or exchange-traded funds and notes — often wonder why the VIX, or the Chicago Board Options Exchange Market Volatility Index, moves much more violently than do the derivative contracts that are based on it.

“This particularly vexes derivative holders when the market plunges and the VIX (which rises as fear grows) climbs by far more than the futures do. I use the futures as a measuring stick, because the prices of the others — options, ETFs, ETNs — are based on the futures’ prices.”

Full article (subscription required): Link

 
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Posted in Implied volatility

 

Measuring High-Frequency Causality between Returns, Realized Volatility and Implied Volatility

28 Sep 2011

Article by: Jean-Marie Dufour, René Garcia, Abderrahim Taamouti
Published by: CIRANO Scientific
Date: 4 Mar 2011

“In this paper, we provide evidence on two alternative mechanisms of interaction between returns and volatilities: the leverage effect and the volatility feedback effect. We stress the importance of distinguishing between realized volatility and implied volatility, and find that implied volatilities are essential for assessing the volatility feedback effect. The leverage hypothesis asserts that return shocks lead to changes in conditional volatility, while the volatility feedback effect theory assumes that return shocks can be caused by changes in conditional volatility through a time-varying risk premium. On observing that a central difference between these alternative explanations lies in the direction of causality, we consider vector autoregressive models of returns and realized volatility and we measure these effects along with the time lags involved through short-run and long-run causality measures proposed in Dufour and Taamouti (2010), as opposed to simple correlations. We analyze 5-minute observations on S&P 500 Index futures contracts, the associated realized volatilities (before and after filtering jumps through the bispectrum) and implied volatilities. Using only returns and realized volatility, we find a strong dynamic leverage effect over the first three days. The volatility feedback effect appears to be negligible at all horizons. By contrast, when implied volatility is considered, a volatility feedback becomes apparent, whereas the leverage effect is almost the same. These results can be explained by the fact that volatility feedback effect works through implied volatility which contains important information on future volatility, through its nonlinear relation with option prices which are themselves forward-looking. In addition, we study the dynamic impact of news on returns and volatility. First, to detect possible dynamic asymmetry, we separate good from bad return news and find a much stronger impact of bad return news (as opposed to good return news) on volatility. Second, we introduce a concept of news based on the difference between implied and realized volatilities (the variance risk premium) and we find that a positive variance risk premium (an anticipated increase in variance) has more impact on returns than a negative variance risk premium.”

Full article (PDF): Link

 
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Posted in Implied volatility, Realized volatility

 
 
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