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)

PDF
MPRA_paper_28538.pdf Download (319kB)  Preview 
Abstract
Under rather general conditions Black  Scholes implied volatilities from atthemoney 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 

Original Title:  The information content of implied volatilities of options on eurodeposit futures traded on the LIFFE: is there long memory? 
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  TimeSeries Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes 
Item ID:  28538 
Depositing User:  Giulio Cifarelli 
Date Deposited:  04 Feb 2011 06:49 
Last Modified:  26 Sep 2019 10:03 
References:  Amin K. and V. K. Ng (1997), “Inferring Future Volatility from the Information in Implied Volatility in Eurodollar Options: A New Approach”, Review of Financial Studies, 10, 333367. Andrews D. W. K. (1991), “Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation”, Econometrica, 59, 817858. Ané T. and H. Geman (1998), “Stochastic Volatility and Transaction Time: An Activity  Based Volatility Estimator”, mimeo, “Forecasting Financial Markets” 1998 Conference, London. Ap Gwilym O. and M. Buckle (1999), “Volatility Forecasting in the Framework of the Option Expiry Cycle”, European Journal of Finance, 5, 7394. Bahra B. (1998), “Implied risk – Neutral Probability Density Functions from Option Prices: A Central Bank Perspective”, in “Forecasting Volatility in the Financial Markets”, j. Knight and S. Satchell (eds.), Butterworth – Heinemann, Oxford. Baillie R. T. and P. C. McMahon (1989), “The Foreign Exchange Market. Theory and Econometric Evidence”, Cambridge University Press, Cambridge. Bhundia A. and J. Chadha (1997), “The Information Content of ThreeMonth Sterling Futures”, mimeo, Bank of England. Black F. (1976), “The Pricing of Commodity Contracts”, Journal of Financial Economics, 3, 167179. Black F. and M. Scholes (1973), “The Pricing of Options and Corporate Liabilities”, Journal of Political Economy, 81, 637659. Brenner R. J., R. H. Harjes and K. F. Kroner (1996), “Another Look at Models of the Short – Term Interest Rate”, Journal of Financial and Quantitative Analysis, 31, 85107. Brys E., M. Bellalah, H.M. Mai and F. De Varenne (1998), “Options, Futures and Exotic Derivatives. Theory, Application and Practice”, John Wiley & Sons, Chichester. Campa J. M. and P. H. K. Chang (1995), “Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options”, Journal of Finance, 50, 529547. Campbell J. Y. and R. J. Shiller (1991), “Yield Spreads and Interest Rate Movements: A Bird’s Eye View”, Review of Economic Studies, 58, 495514. Canina L. and S. Figlewski (1993), “The Informational Content of Implied Volatility”, Review of Financial Studies, 6, 659681. Chiras D. P. and S. Manaster (1978), “The Information Content of Option Prices and a Test of Market Efficiency”, Journal of Financial Economics, 6, 213234. Chong Y.Y. and D. H. Hendry (1986), “Econometric Evaluation of Linear MacroEconometric Models”, Review of Economic Studies, 53, 671690. Christensen B. J. and N. R. Prabhala (1998), “The Relation Between Implied and Realized Volatility”, Journal of Financial Economics, 50, 125150. Cochrane J. H. (1988), “How Big is the Random Walk Component in GNP?”, Journal of Political Economy, 96, 893920. Day T. E. and C. M. Lewis (1988), “The Behavior of the Volatility Implied in the Prices of Stock Index Options”, Journal of Financial Economics, 22, 103122. Day T. E. and C. M. Lewis (1992), “Stock Market Volatility and the Information Content of Stock Index Options”, Journal of Econometrics, 52, 267287. Diebold F. X. and Rudebusch (1991), “On the Power of Dickey – Fuller Tests Against Fractional Alternatives”, Economics Letters, 35, 155160. Diz F. and T. J. Finucane (1993), “Do the Option Markets Really Overreact?”, Journal of Futures Markets, 13, 299312. Duan J.C. (1995), “The GARCH Option Pricing Model”, Mathematical Finance, 5, 1332. Engle R., T. Ito and W.L. Lin (1992), “Meteor Showers or Heat Waves? Heteroskedastic IntraDaily Volatility in the Foreign Exchange Market”, Econometrica, 58, 525542. Fair R. C. and R. J. Shiller (1990), “Comparing Information in Forecasts from Econometric Models”, American Economic Review, 80, 375389. Feinstein S. (1989), “The BlackScholes Formula is Nearly Linear in for AtTheMoney Options”, Presentation at the AFA Conference, Washington, D.C.. Fleming J. (1993), “The Quality of Market Volatility Forecasts Implied by S&P 100 Index Option Prices”, Working Paper, Duke University, N.C.. Franks J. R. and E. S. Schwartz (1991), “The Stochastic Behaviour of Market Variance Implied in the Prices of Index Options”, Economic Journal, 101, 14601475. Granger C. W. J. and P. Newbold (1974), “Spurious Regressions in Econometrics”, Journal of Econometrics, 2, 111120. Hansen L. P. (1982), “Large Sample Properties of Generalized Methods of Moments Estimators”, Econometrica, 50, 10291054. Heynen R., A. Kemna and T. Vorst (1994), “Analysis of the Term Structure of Implied Volatilities”, Journal of Financial and Quantitative Analysis, 29, 3156. Hosking J. R. M. (1981), “Fractional Differencing”, Biometrika, 68, 165176. Hull J. and A. White (1987), “The Pricing of Options on Assets with Stochastic Volatilities”, Journal of Finance, 42, 281300. Hwang S. and S. E. Satchell (1998), “Implied Volatility Forecasting: A Comparison of Different Procedures Including Fractionally Integrated Models with Applications to UK Equity Options”, in “Forecasting Volatility in the Financial Markets”, J. Knight and S. Satchell (eds.), Butterworth  Heinemann, Oxford. Jorion P. (1995), “Predicting Volatility in the Foreign Exchange Market”, Journal of Finance, 50, 507528. Kodres L. and Pritsker M. (1999), “A Rational Expectations Model of Financial Contagion”, mimeo, Board of Governors of the Federal Reserve System. Lamoureux C. G. and W. D. Lastrapes (1993), “Forecasting Stock  Return Variance: Toward an Understanding of Stochastic Implied Volatilities”, Review of Financial Studies 6, 293326. Latané H. A. and R. J. Rendleman (1976), “Standard Deviations of Stock Price Ratios Implied in Option Prices”, Journal of Finance, 31, 369381. Lieu D. (1990), “Option Pricing with FuturesStyle Margining”, Journal of Futures Markets, 10, 327338. Masson P. (1998), “Contagion, Monsoonal Effects, Spillovers and Jumps Between Multiple Equilibria”, IMF Working Paper n. 98/142. McLeod A. I. and K. W. Hipel (1978), “Preservation of Rescaled Adjusted Range. A Reassessment of the Hurst Phenomenon”, Water Resources Research, 14, 491508. Neuhaus H. (1995), “The Information Content of Derivatives for Monetary Policy”, Discussion Paper 3/95, Economic Research Group of the Deutsche Bundesbank. Phillips P. C. B. (1986), “Understanding Spurious Regressions in Econometrics”, Journal of Econometrics, 33, 311340. Schmalensee R. and R. R. Trippi (1978), “Common Stock Volatility Expectations Implied by Option Premia”, Journal of Finance, 33, 129147. Scott E. and A. Tucker (1989), “Predicting Currency Returns Volatility”, Journal of Banking and Finance, 13, 839851. Scott L. O. (1992), “The Information Content of Prices in the Derivative Security Markets”, International Monetary Fund Staff Papers, 39, 596625. Stein J. C. (1989), “Overreactions in the Option Market”, Journal of Finance, 44, 10111023. Tan J. (1998), “Contagion Effect During the Asian Financial Crisis: Some Evidence from Stock Price Data”, Pacific Basin Working Paper Series n. PB9806, Federal Reserve Bank of San Francisco. Tessaromatis N. (1998), “Volatility in Currency Markets”, mimeo, “Forecasting Financial Markets” 1998 Conference, London. Xu X. and S. J. Taylor (1994), “The Term Structure of Volatility Implied by Foreign Exchange Options”, Journal of Financial and Quantitative Analysis, 29, 5774. Xu X. and S. J. Taylor (1995), “Conditional Volatility and the Informational Efficiency of the PHLX Currency Options Market”, Journal of Banking and Finance, 19, 803821. 
URI:  https://mpra.ub.unimuenchen.de/id/eprint/28538 