Can we forecast the implied volatility surface dynamics of equity options? Predictability and economic value tests
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2014Metadata
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Bernales Silva, Alejandro
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Can we forecast the implied volatility surface dynamics of equity options? Predictability and economic value tests
Abstract
We examine whether the dynamics of the implied volatility surface of individual equity options contains
exploitable predictability patterns. Predictability in implied volatilities is expected due to the learning
behavior of agents in option markets. In particular, we explore the possibility that the dynamics of the
implied volatility surface of individual stocks may be associated with movements in the volatility surface
of S&P 500 index options. We present evidence of strong predictable features in the cross-section of
equity options and of dynamic linkages between the volatility surfaces of equity and S&P 500 index
options. Moreover, time-variation in stock option volatility surfaces is best predicted by incorporating
information from the dynamics in the surface of S&P 500 options. We analyze the economic value of such
dynamic patterns using strategies that trade straddle and delta-hedged portfolios, and find that before
transaction costs such strategies produce abnormal risk-adjusted returns.
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URI: https://repositorio.uchile.cl/handle/2250/126570
DOI: 10.1016/j.jbankfin.2014.06.002
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Journal of Banking & Finance 46 (2014) 326–342
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