Liquidity considerations in estimating implied volatility

Rohini Grover and Susan Thomas
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Rohini Grover: Indira Gandhi Institute of Development Research

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

Abstract: Some option series in the market are far less liquid than others. Market illiquidity can reduce the informativeness of option prices. In this paper, we propose alternative schemes to estimate implied volatility while reducing the importance attached to illiquid options. Using data for index options traded at the National Stock Exchange in India, we and that the performance of a liquidity weighted scheme is superior to that of more conventional schemes such as the vega weights, the volatility elasticity weights and the traditional vxo. Liquidity weights offers the possibility of improved implied volatility estimation in situations where there is strong cross-sectional variation in option market liquidity.

Keywords: liquidity; implied volatility; volatility index; Indian index options market (search for similar items in EconPapers)
JEL-codes: G12 G13 G17 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2011-03
New Economics Papers: this item is included in nep-mst
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http://www.igidr.ac.in/pdf/publication/WP-2011-006.pdf (application/pdf)

Related works:
Journal Article: Liquidity Considerations in Estimating Implied Volatility (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:ind:igiwpp:2011-006

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