Three Essays On Volatility

Hsieh, Peilin

Three Essays On Volatility

Abstract

My dissertation focuses on economic studying of volatility issues. Three essays are contained in my dissertation. Essay 1 extends a microstructure model to explain the change of volatility and thus links traders' belief to the volatility change. Our model shows that when market is more uncertain about the value of the stock, the higher the (return) volatility. Essay 2 turns to explore more economic factors that could cause volatility regime switch. We find that US stock return processes, including drift, diffusion, and jump, differ along with US political cycle. Our results imply that the presidency in different parties has distinct policy making processes and thus influence the way information flows into the market, altering the return processes. In the final essay, we document and explain a volatility Bid-Ask spread pattern that increases as time to maturity decreases. Our research develops a model that explains the volatility spread pattern. We show that, as time passes, the required hedging uncertainty premium charged by the liquidity providers decays more slowly while the premium contained in the quoted options price decays at an increasingly higher rate which is determined by the option pricing model. Therefore, liquidity providers need to increase asking and decrease bidding volatility to maintain the profit necessary to compensate slowly decaying hedging uncertainty premium. Our results strongly suggest that studies on volatility spread should detrend the data to make the estimation models correct as well as the series stationary. Without adjusting the trend and autocorrelation problems, statistical results are inaccurate and misleading. More importantly, based on our theoretical model, we also find that: (a) the implied volatility spread does not increase in proportion to the increase of implied volatility, and (b) the increase of volatility uncertainty is not a sufficient condition for an increase in the percentage spread. Finally, to augment the validity of our claims, we provide rigorous econometric tests which support our propositions.

Date Issued

2013-05-26

Keywords

Volatility; Implied Volatility; Options

Committee Chair

Hong, Yongmiao

Committee Co-Chair

Jarrow, Robert A.

Committee Member

Easley, David Alan

Degree Discipline

Economics

Degree Name

Ph. D., Economics

Degree Level

Doctor of Philosophy

Types

dissertation or thesis