The information content of implied volatilities of options on eurodeposit futures traded on the LIFFE: is there long memory?

Cifarelli, giulio (2002): The information content of implied volatilities of options on eurodeposit futures traded on the LIFFE: is there long memory? Published in: Studi e Discussioni - Dipartimento di Scienze Economiche - Università di Firenze No. n. 128 (May 2002)

Abstract

Under rather general conditions Black - Scholes implied volatilities from at-the-money options appropriately quantify, in each period, the market expectations of the average volatility of the return of the underlying asset until contract expiration. The efficiency of these expectation estimates is investigated here, for options on two major short term interest rate futures contracts traded at the LIFFE, using a long memory framework. Over the 1993 – 1997 time interval the performance of implied volatilities is not homogeneous across contracts. Information content and predictive power tests consistently suggest that implied volatility from Short Sterling contracts is more accurate as a future volatility predictor than implied volatility from 3 Month Euromark contracts. The analysis of the efficiency of the transmission of news over time and between contracts provides analogous results. Underreaction of long term volatility to changes in short term volatility is more relevant for the German interest rate contract than for the British one and Short Sterling implied volatility changes do “Granger cause” 3 Month Euromark implied volatility changes pointing to a contagion – like interlinkage. Even in a sophisticated international financial market like the LIFFE implied volatilities have a country specific pattern as traders seem to be more proficient in predicting domestic interest rate volatility. A possible interpretation is that a (foreign) country risk premium introduces a bias in the Black – Scholes implied volatility estimates. Whether this result is general or is instead restricted to the time period and/or to the contracts under investigation provides the scope for future research.

• Item Type: MPRA Paper
• Language: English
• Keywords: Options; stochastic volatility; long memory; ARFIMA
• Subjects: G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes

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