The Determinants of Implied Volatility: A Test Using LIFFE Option Prices

Abstract

This paper presents and tests a model of the volatility of individual companies' stocks, using implied volatilities derived from option prices. The data comes from traded options quoted on the London International Financial Futures Exchange. The model relates equity volatilities to corporate earnings announcements, interest-rate volatility and to four determining variables representing leverage, the degree of fixed-rate debt, asset duration and cash flow inflation indexation. The model predicts that equity volatility is positively related to duration and leverage and negatively related to the degree of inflation indexation and the proportion of fixed-rate debt in the capital structure. Empirical results suggest that duration, the proportion of fixed-rate debt, and leverage are significantly related to implied volatility. Regressions using all four determining variables explain approximately 30% of the cross-sectional variation in volatility. Time series tests confirm an expected drop in volatility shortly after the earnings announcement and in most cases a positive relationship between the volatility of the stock and the volatility of interest rates. Copyright Blackwell Publishers Ltd 2000.

The options market response to accounting earnings announcements

“…First, unconditional on earnings news, we find a general increase in implied volatility in the 10 days leading up to an earnings announcement, followed by a significant decline in implied volatility immediately subsequent to the earnings announcement. This confirms findings in prior studies, which generally found a build-up in uncertainty in the immediate pre-announcement period manifested by rising implied volatility, then a resolution of the uncertainty accompanying the release of earnings news manifested by a decline in implied volatility Wolfson, 1979, 1981;Donders and Vorst, 1996;Copeland et al, 2000;Donders et al, 2000;Isakov and Perignon, 2001;Acker, 2002). 4 Both the run-up of implied volatility in the pre-announcement period and the decline of implied volatility in the post-announcement period are most pronounced for options with shorter maturities and less so for options with longer maturities, which suggests that the impact of earnings announcements on expected future volatility is transitory.…”

A Jump Diffusion Model for VIX Volatility Options and Futures

“…Such changes may arise as a response to changes in macroeconomic or microeconomic conditions (see, for example, Copeland et al, 2000).…”

Scheduled announcements and volatility patterns: The effects of monetary policy committee announcements on LIBOR and short sterling futures and options

“…Some of these studies have analysed various scheduled announcements: twelve macroeconomic announcements (Ederington and Lee, 1996), three macroeconomic announcements (Li & Engle, 1998), company earnings (Patell & Wolfson, 1979, 1981, Donders & Vorst, 1996, Copeland, Poon & Stapleton, 2000, the balance of trade (Madura & Tucker, 1992), the money supply (Bailey, 1988), a general election (Gemmill, 1992) and interest rate changes (Bomfim & Reinhart, 2000). Other studies have looked at the effects of unscheduled announcements on implied volatility: ten major news announcements (Cornell, 1978), takeovers (Barone-Adesi, Brown & Harlow, 1994), mergers (Jayaraman et al, 1991, Levy & Yoder, 1993, interest rate changes (French & Fraser, 1986), the effect of the Louvre Accord on volatility in currency markets (Tucker & Madura, 1991), central bank intervention in the foreign exchange market (Bonser-Neal, 1996, Bonser-Neal & Tanner, 1996 and dividend increases (Jayaraman & Shastri, 1993).…”