The Stochastic behaviour of Market Variance Implied in the Prices of Index Options

Options on index prices are used to obtain time series estimates of market volatility. The analysis seeks to explain innovations in volatility using leverage, volume, and other variables. Contrary to Christie's (1982) findings, the results show that leverage could be a significant explanatory v...

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Bibliographic Details
Published in:The Economic journal (London) 1991-11, Vol.101 (409), p.1460-1475
Main Authors: Franks, Julian R., Schwartz, Eduardo S.
Format: Article
Language:English
Subjects:
Call options
Comparative studies
Dividends
Economic models
Economic theory
Economics
Equity
Interest rates
Market
Market prices
Options markets
Options trading
Periodical indexing
Price volatility
Prices
Regression analysis
Risk premiums
Standard deviation
Stock exchanges
Stock market indices
Stock prices
Time series
Variables
Volatility
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Summary:Options on index prices are used to obtain time series estimates of market volatility. The analysis seeks to explain innovations in volatility using leverage, volume, and other variables. Contrary to Christie's (1982) findings, the results show that leverage could be a significant explanatory variable but that it cannot be the only one. As a result, further tests are conducted in an attempt to identify other variables that may explain changes in the volatility of the underlying assets. The results show that, irrespective of the period chosen, inflation is a significant additional explanatory variable. In addition, long-term nominal interest rates are significant if the period of the October 1987 stock market crash is excluded. Finally, it is found that many of the innovations in volatility do not persist for very long periods. The result has important implications for how to estimate volatilities over varying time horizons and for the impact of volatility changes on the market's estimated risk premium.
ISSN:0013-0133
1468-0297
DOI:10.2307/2234896