The Determinants of Bias of Model-Free Implied Volatility
Date Issued
2009
Date
2009
Author(s)
Wang, Chu-Yu
Abstract
In practice, people used to use implied volatility to estimate the future volatility. However, the previous studies find both Black-Sholes implied volatility and model-free implied volatility are biased and inefficient. The purpose of this paper is to investigate the determinants of implied volatility bias. From previous studies, we summarize the probable factors, including market momentum, market liquidity, market sentiment, market jump, and transaction cost. Then we test them into our time-series regression model. The result shows that all the factors are robust. In addition, we want to figure out the effect of market crash, so we separate our data into two subsamples and test them respectively. The result is similar to the full sample result, except the market sentiment factor is only significant in post-market-crash sample. Because investors are more sensitive in the bearish market, they buy more put options and the net put buying pressure affect the shape of implied volatility, hence the bias is generated.
Subjects
Implied Volatility
Market Momentum
Market Sentiment
Type
thesis
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