Title: Analysing implied volatilities between stock and dividend markets
Authors: Enoch Nii Boi Quaye - University of Kent (United Kingdom) [presenting]
Radu Tunaru - University of Kent (United Kingdom)
Abstract: A computational approach is proposed to compare the information in the implied volatility of stock index options to the information in the implied volatility of index dividend options. The approach uses the implied volatility surface (IVs) as a stochastic state variable accounting for the evolution of the underlying asset price process. The proposed method explicitly allows for variability in time-to-maturity, and outlines a computational process for the aggregation of volatility measures under the Black-Scholes, the Black model and model-free approaches. The study illustrates how the implied volatility term-structure of stock index option contracts with time-to-maturity exceeding ``9-months" move enough to be justified by subsequent fluctuations in dividends although contracts with time-to-maturities around ``1-month", ``1-3 months" and ``3-9 months" move too much to be justified by subsequent changes in dividends. The IVs term-structure shows that the implied volatility of stock index options consistently exceeds that of index dividend options, thereby confirming previous criticism based on novel financial data and instruments. However, we show that the magnitude of excess implied volatility declines with long-dated time-to-maturities, suggesting that the discrepancy between the two implied volatilities is sensitive to investment horizon.