Abstract
With machine learning tools, we document that firm fundamentals have explanatory power on the shape of the option implied volatility (IV) curve that is both economically and statistically significant. We also find that, after accounting for fundamentals, the associated IV process can generate overreaction in the long-term IV with respect to change in the short-term IV, and can allow a positive profit from at-the-money straddle writing, explaining puzzling patterns in the literature. We also provide a simple model linking the IV to firm fundamentals, which permits realistic IV curves and is consistent with the empirical findings.
| Original language | English |
|---|---|
| Article number | 100771 |
| Number of pages | 22 |
| Journal | Journal of Financial Markets |
| Volume | 63 |
| Early online date | 6 Aug 2022 |
| DOIs | |
| Publication status | Published - Mar 2023 |
Bibliographical note
Funding Information:We are grateful to Tarun Chordia (the editor) and an anonymous referee for very insightful and helpful comments that significantly improved the paper. We thank Carol Alexander, Gurdip Bakshi, Jie Cao, Jin-Chuan Duan, Steven Heston, Ranko Jelic, Andreas Kaeck, Hai Lin, Hong Liu, Zhan Shi, Ke Tang, and Hao Zhou, the participants of the XXVI AEFIN Finance Forum, the 2021 China Derivatives Youth Forum, and the 2021 China International Conference of Finance (CICF), and the participants of the seminars at Renmin University of China, University of Nottingham (Ningbo), University of Sussex, and Washington University in St. Louis for their helpful comments and suggestions. This work was supported by the National Natural Science Foundation of China [No. 72171225].
Publisher Copyright:
© 2022
Keywords
- Firm fundamentals
- LASSO
- Option implied volatility
- Option puzzle
- Volatility skew
ASJC Scopus subject areas
- Finance
- Economics and Econometrics