A Test of Efficiency for the S&P Index Option Market Using Variance Forecasts / Jaesun Noh, Robert F. Engle, Alex Kane.

Format:

Book

Author/Creator:

Noh, Jaesun.

Contributor:

National Bureau of Economic Research.

Engle, Robert F.

Kane, Alex.

Series:

Working Paper Series (National Bureau of Economic Research) no. w4520.

NBER working paper series no. w4520

Language:

English

Subjects (All):

Obesity--Economic aspects.

Obesity.

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1993.

Cambridge, Massachusetts : National Bureau of Economic Research, 1993.

Summary:

To forecast future option prices, autoregressive models of implied volatility derived from observed option prices are commonly employed [see Day and Lewis (1990), and Harvey and Whaley (1992)]. In contrast, the ARCH model proposed by Engle (1982) models the dynamic behavior in volatility, forecasting future volatility using only the return series of an asset. We assess the performance of these two volatility prediction models from S&P 500 index options market data over the period from September 1986 to December 1991 by employing two agents who trade straddles, each using one of the two different methods of forecast. Straddle trading is employed since a straddle does not need to be hedged. Each agent prices options according to her chosen method of forecast, buying (selling) straddles when her forecast price for tomorrow is higher (lower) than today's market closing price, and at the end of each day the rates of return are computed. We find that the agent using the GARCH forecast method earns greater profit than the agent who uses the implied volatility regression (IVR) forecast model. In particular, the agent using the GARCH forecast method earns a profit in excess of a cost of $0.25 per straddle with the near-the-money straddle trading.

Notes:

Print version record

November 1993.