# Category: All Research Papers

## R.J. McGee, F. McGroarty, “The Risk Premium That Never Was: A Fair Value Explanation of the Volatility Spread”

We present a new framework to investigate the profitability of trading the volatility spread, the upward bias on implied volatility as an estimator of future realized volatility. The scheme incorporates the first four option-implied moments in a growth-optimal payoff that is statically replicated using a portfolio of options. Removing the upward bias on implied volatility worsens the likelihood score of … Read More »

## R. Israelov – “Pathetic Protection: The Elusive Benefits of Protective Puts”

Conventional wisdom is that put options are effective drawdown protection tools. Unfortunately, in the typical use case, put options are quite ineffective at reducing drawdowns versus the simple alternative of statically reducing exposure to the underlying asset. This paper investigates drawdown characteristics of protected portfolios via simulation and a study of the CBOE S&P 500 5% Put Protection Index. Unless your option purchases and their maturities are timed just right around equity drawdowns, they may offer little downside protection. In fact, they could make things worse by increasing rather than decreasing drawdowns and volatility per unit of expected return.Read More »

## N. Branger, H. Hulsbusch, T. F. Middelhoff, “Idiosyncratic Volatility, its Expected Variation, and the Cross-Section of Stock Returns”

This paper explains the negative relation between the realized idiosyncratic volatility (IVOL) and expected returns. Using implicit information from the cross-section of options we extract expectations about the volatility of idiosyncratic volatility (IVOLVOL) in an almost model-free fashion. We show that IVOL is mean-reverting and that IVOLVOL serves as proxy for the meanreversion speed. Running double sorts on both measures … Read More »

## Y. Yang, Y. Zheng, T.M. Hospedales – “Gated Neural Networks for Option Pricing: Rationality by Design”

We propose a neural network approach to price EU call options that significantly outperforms some existing pricing models and comes with guarantees that its predictions are economically reasonable. To achieve this, we introduce a class of gated neural networks that automatically learn to divide-and-conquer the problem space for robust and accurate pricing. We then derive instantiations of these networks that are ‘rational by design’… Read More »

## S. C. Anagnostopoulou, A. Tsekrekos – “Accounting Quality, Information Risk and Implied Volatility around Earnings Announcements”

Abstract: We examine the impact of accounting quality, used as a proxy for information risk, on the behavior of equity implied volatility around quarterly earnings announcements. Using US data during 1996-2010, we observe that lower (higher) accounting quality significantly relates to higher (lower) levels of implied volatility (IV) around announcements. Worse accounting quality is further associated with a significant increase … Read More »

## S. C. Anagnostopoulou, A. Ferentinou, P. Tsaousis, A. Tsekrekos – “The Option Market Reaction to Bank Loan Announcements”

Abstract: In this study, we examine the options market reaction to bank loan announcements for the population of US firms with traded options and loan announcements during 1996–2010. We get evidence on a significant options market reaction to bank loan announcements in terms of levels and changes in short-term implied volatility and its term structure, and observe significant decreases in … Read More »

## C. Moll, S. Huffman – “The Incremental Information Content of Innovations in Implied Idiosyncratic Volatility”

Motivated by mixed evidence related to the pricing of measures of risk, we investigate the information content of innovations in implied idiosyncratic volatility. Using both cross-sectional and time-series methodologies, we find that innovations in implied idiosyncratic volatility explain future returns for a sample of 2,864 optionable firms examined during the 1999-2010 sample period. We find that long-short… Read More »

## J. Faias, P. Santa-Clara, “Optimal Option Portfolio Strategies: Deepening the Puzzle of Index Option Mispricing”

Traditional methods of asset allocation (such as mean-variance optimization) are not adequate for option portfolios because the distribution of returns is non-normal and the short sample of option returns available makes it difficult to estimate their distribution. We propose a method to optimize a portfolio of European options, held to maturity, with a myopic objective function that overcomes these limitations… Read More »

## F. Audrino, D. Colangelo, “Semi-parametric forecasts of the implied volatility surface using regression trees”

Abstract: We present a new semi-parametric model for the prediction of implied volatility surfaces that can be estimated using machine learning algorithms. Given a reasonable starting model, a boosting algorithm based on regression trees sequentially minimizes generalized residuals computed as differences between observed and estimated implied volatilities. To overcome the poor predictive power of existing models, we include a grid … Read More »

## P. Borochin, Y. Zhao, “Variation of the Implied Volatility Function and Return Predictability”

Abstract: The variation of the shape of the implied volatility function (IVF) has significant predictive power for future performance, above that previously documented for the shape of the IVF itself. We find that standard deviations of IV spreads describing the shape of the IVF over the current month are negatively correlated with next month’s realized returns. This effect is strongest … Read More »