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. 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 »

S. Choy, J. Wei, “Liquidity Risk and Expected Option Returns”

Abstract: Using data from OptionMetrics for the period of 1996 to 2013, we establish the existence of liquidity risk premium in option returns via both sorting analyses and Fama-MacBeth regressions. In leverage-adjusted, hedged returns, the alpha due to liquidity risk ranges from 11.2 basis points to 19.7 basis points per month. In hedged returns unadjusted for leverage, the alpha ranges … Read More »

A. Manela, A. Moreira, “News Implied Volatility and Disaster Concerns”

Abstract: We construct a text-based measure of uncertainty starting in 1890 using front-page articles of the Wall Street Journal. News implied volatility (NVIX) peaks during stock market crashes, times of policy-related uncertainty, world wars and financial crises. In US post-war data, periods when NVIX is high are followed by periods of above average stock returns, even after controlling for contemporaneous … Read More »

W. Farkas, C. Necula, B. Waelchli, “Herding and Stochastic Volatility”

Abstract: In this paper we develop a one-factor non-affine stochastic volatility option pricing model where the dynamics of the underlying is endogenously determined from micro-foundations. The interaction and herding of the agents trading the underlying asset induce an amplification of the volatility of the asset over the volatility of the fundamentals. Although the model is non-affine, a closed form option … Read More »

J. Martin, G.Wang, “Are Active Managers a Drag on Investor Wealth? Evidence from an Option-Based Estimation”

Abstract: We estimate an option-based value of a fund manager’s conditional market timing skill in bear market states. We combine this value with alpha based estimates of selection skill to give an overall valuation of active management. At the aggregate level, we estimate that the benefit arising from the option value of active fund management in bad times can be … Read More »