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138
Estimating standard errors in finance panel data sets: comparing approaches.
- Review of Financial Studies
, 2009
"... Abstract In both corporate finance and asset pricing empirical work, researchers are often confronted with panel data. In these data sets, the residuals may be correlated across firms and across time, and OLS standard errors can be biased. Historically, the two literatures have used different solut ..."
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Cited by 890 (7 self)
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Abstract In both corporate finance and asset pricing empirical work, researchers are often confronted with panel data. In these data sets, the residuals may be correlated across firms and across time, and OLS standard errors can be biased. Historically, the two literatures have used different solutions to this problem. Corporate finance has relied on clustered standard errors, while asset pricing has used the Fama-MacBeth procedure to estimate standard errors. This paper examines the different methods used in the literature and explains when the different methods yield the same (and correct) standard errors and when they diverge. The intent is to provide intuition as to why the different approaches sometimes give different answers and give researchers guidance for their use.
Does net buying pressure affect the shape of implied volatility functions
- Journal of Finance
, 2004
"... This paper examines the relation between net buying pressure and the shape of the implied volatility function (IVF) for index and individual stock options. We find that changes in implied volatility are directly related to net buying pressure from public order flow. We also find that changes in impl ..."
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Cited by 146 (3 self)
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This paper examines the relation between net buying pressure and the shape of the implied volatility function (IVF) for index and individual stock options. We find that changes in implied volatility are directly related to net buying pressure from public order flow. We also find that changes in implied volatility of S&P 500 options are most strongly affected by buying pressure for index puts, while changes in implied volatility of stock options are dominated by call option demand. Simulated delta-neutral option-writing trading strategies generate abnormal returns that match the deviations of the IVFs above realized historical return volatilities. If people are willing to pay foolish prices for insurance, why shouldn’t we sell it to them? (Lowenstein (2000)). ONE OF THE MOST INTRIGUING ANOMALIES REPORTED in the derivatives literature is the “implied volatility smile. ” The name arose from the fact that, prior to the October 1987 market crash, the relation between the Black and Scholes (1973) implied volatility of S&P 500 index options and exercise price gave the ap-
Delta-Hedged Gains and the Negative Market Volatility Risk Premium
- The Review of Financial Studies
, 2001
"... We investigate whether the volatility risk premium is negative by examining the statistical properties of delta-hedged option portfolios (buy the option and hedge with stock). Within a stochastic volatility framework, we demonstrate a correspondence between the sign and magnitude of the volatility r ..."
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Cited by 122 (5 self)
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We investigate whether the volatility risk premium is negative by examining the statistical properties of delta-hedged option portfolios (buy the option and hedge with stock). Within a stochastic volatility framework, we demonstrate a correspondence between the sign and magnitude of the volatility risk premium and the mean delta-hedged portfolio returns. Using a sample of S&P 500 index options, we provide empirical tests that have the following general results. First, the delta-hedged strategy underperforms zero. Second, the documented underperformance is less for options away from the money. Third, the underperformance is greater at times of higher volatility.Fourth, the volatility risk premium significantly affects delta-hedged gains even after accounting for jump-fears. Our evidence is supportive of a negative market volatility risk premium.
The Information Content of Option-Implied Volatility for Credit Default Swap Valuation. Working Paper
, 2005
"... Abstract Credit default swaps (CDS) are similar to out-of-the-money put options in that both offer a low cost and effective protection against downside risk. This study investigates whether put optionimplied volatility is an important determinant of CDS spreads. Using a large sample of firms with b ..."
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Cited by 39 (0 self)
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Abstract Credit default swaps (CDS) are similar to out-of-the-money put options in that both offer a low cost and effective protection against downside risk. This study investigates whether put optionimplied volatility is an important determinant of CDS spreads. Using a large sample of firms with both CDS and options data, we find that individual firms' put option-implied volatility dominates historical volatility in explaining the time-series variation in CDS spreads. To understand this result, we show that implied volatility is a more efficient forecast for future realized volatility than historical volatility. More importantly, the volatility risk premium embedded in option prices covaries with the CDS spread. These findings complement existing empirical evidence based on market-level data.
The price of correlation risk: Evidence from equity options
- Journal of Finance, 64(3):1377
"... We study whether exposure to marketwide correlation shocks affects expected option returns, using data on S&P100 index options, options on all components, and stock returns. We find evidence of priced correlation risk based on prices of index and indi-vidual variance risk. A trading strategy exp ..."
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Cited by 38 (5 self)
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We study whether exposure to marketwide correlation shocks affects expected option returns, using data on S&P100 index options, options on all components, and stock returns. We find evidence of priced correlation risk based on prices of index and indi-vidual variance risk. A trading strategy exploiting priced correlation risk generates a high alpha and is attractive for CRRA investors without frictions. Correlation risk exposure explains the cross-section of index and individual option returns well. The correlation risk premium cannot be exploited with realistic trading frictions, provid-ing a limits-to-arbitrage interpretation of our finding of a high price of correlation risk. CORRELATIONS PLAY A CENTRAL ROLE in financial markets. There is considerable ev-idence that correlations between asset returns change over time1 and that stock return correlations increase when returns are low.2 A marketwide increase in correlations negatively affects investor welfare by lowering diversification ben-efits and by increasing market volatility, so that states of nature with unusually high correlations may be expensive. It is therefore natural to ask whether mar-ketwide correlation risk is priced in the sense that assets that pay off well when marketwide correlations are higher than expected (thereby providing a ∗Driessen is at the University of Amsterdam. Maenhout and Vilkov are at INSEAD. We would
Understanding the Role of Recovery in Default Risk Models: Empirical Comparisons and Implied Recovery Rates
, 2006
"... This article presents a framework for studying the role of recovery on defaultable debt prices for a wide class of processes describing recovery rates and default probability. These debt models have the ability to differentiate the impact of recovery rates and default probability, and can be employe ..."
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Cited by 36 (0 self)
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This article presents a framework for studying the role of recovery on defaultable debt prices for a wide class of processes describing recovery rates and default probability. These debt models have the ability to differentiate the impact of recovery rates and default probability, and can be employed to infer the market expectation of recovery rates implicit in bond prices. Empirical implementation of these models suggests two central findings. First, the recovery concept that specifies recovery as a fraction of the discounted par value has broader empirical support. Second, parametric debt valuation models can provide a useful assessment of recovery rates embedded in bond prices.
Stochastic Risk Premiums, Stochastic Skewness
- in Currency Options, and Stochastic Discount Factors in International Economies,”
, 2008
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Individual Stock-Option Prices and Credit Spreads, working paper,
, 2004
"... Individual stock-option prices and credit spreads Cremers, M.; Driessen, J.J.A.G.; Maenhout, P.; Weinbaum, D. General rights It is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s) and/or copyright holder(s), other than for strictly pers ..."
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Cited by 35 (3 self)
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Individual stock-option prices and credit spreads Cremers, M.; Driessen, J.J.A.G.; Maenhout, P.; Weinbaum, D. General rights It is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s) and/or copyright holder(s), other than for strictly personal, individual use, unless the work is under an open content license (like Creative Commons). Disclaimer/Complaints regulations If you believe that digital publication of certain material infringes any of your rights or (privacy) interests, please let the Library know, stating your reasons. In case of a legitimate complaint, the Library will make the material inaccessible and/or remove it from the website. Please Ask the Library: https://uba.uva.nl/en/contact, or a letter to: Library of the University of Amsterdam, Secretariat, Singel 425, 1012 WP Amsterdam, The Netherlands. You will be contacted as soon as possible. Abstract This paper introduces measures of volatility and jump risk that are based on individual stock options to explain credit spreads on corporate bonds. Implied volatilities of individual options are shown to contain useful information for credit spreads and improve on historical volatilities when explaining the cross-sectional and time-series variation in a panel of corporate bond spreads. Both the level of individual implied volatilities and (to a lesser extent) the implied-volatility skew matter for credit spreads. Detailed principal component analysis shows that a large part of the time-series variation in credit spreads can be explained in this way. JEL Classification: G12 ; G13
Investor sentiment and option prices
- Review of Financial Studies
, 2008
"... This paper examines whether investor sentiment about the stock market affects prices of the S&P 500 options. The findings reveal that the index option volatility smile is steeper (flatter) and the risk-neutral skewness of monthly index return is more (less) negative when market sentiment becomes ..."
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Cited by 26 (1 self)
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This paper examines whether investor sentiment about the stock market affects prices of the S&P 500 options. The findings reveal that the index option volatility smile is steeper (flatter) and the risk-neutral skewness of monthly index return is more (less) negative when market sentiment becomes more bearish (bullish). These significant relations are robust and become stronger when there are more impediments to arbitrage in index options. They cannot be explained by rational perfect-market-based option pricing models. Changes in investor sentiment help explain time variation in the slope of index option smile and risk-neutral skewness beyond factors suggested by the current models. (JEL G12, G13, G14) Jackwerth and Rubinstein (1996) find a pronounced “smile ” effect for S&P 500 options: the Black-Scholes implied volatilities decrease monotonically with the strike price. This is in stark contrast to the Black-Scholes option pricing the-ory under which implied volatilities for options on the same underlying asset should be identical. Generalizations of the Black-Scholes model within the rational representative-agent perfect-market framework can fit the option data better (e.g., Bakshi, Cao, and Chen, 1997; Pan, 2002). However, there are dis-
Closed-form transformations from risk neutral to real-world distributions
- Journal of Banking and Finance
, 2007
"... Risk-neutral (RN) and real-world (RW) densities are derived from option prices and risk assumptions, and are compared with densities obtained from historical time series. Two parametric methods that adjust from RN to RW densities are investigated, firstly a CRRA risk aversion transformation and seco ..."
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Cited by 24 (6 self)
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Risk-neutral (RN) and real-world (RW) densities are derived from option prices and risk assumptions, and are compared with densities obtained from historical time series. Two parametric methods that adjust from RN to RW densities are investigated, firstly a CRRA risk aversion transformation and secondly a statistical calibration. Both risk transformations are estimated using likelihood techniques, for two flexible but tractable density families. Results for the FTSE-100 index show that densities derived from option prices have more explanatory power than historical time series. Furthermore, the pricing kernel between RN & RW densities may be more regular than previously reported and a more reasonable risk aversion function is estimated. 2 Closed-form Transformations from Risk-neutral to Real-world Distributions 1.
