The 2008 UK Banking Crash: Evidence from Option Implied Volatility

Ha Yan Raymond So, Tarik Driouchi and Zhiyuan Simon Tan

Chapter 9 in Advances in Financial Risk Management, 2013, pp 201-224 from Palgrave Macmillan

Abstract: Abstract The 2007–9 Great Recession reached its culmination point in 15 September 2008 with the demise of Lehman Brothers and the near collapse of the global financial system. A major banking crash would follow as a result of impending stock markets mayhem and abnormal credit risk contagion (Bartram and Bodnar, 2009; Longstaff, 2010). UK banking institutions in particular were severely affected by this turn of events. The oligopolistic structure of the industry and the weight of financial services in the UK economy did not facilitate recovery expost. Although losses incurred were somewhat unpredictable, the crisis itself did not come as a surprise. Early signs for a global downturn looming could be spotted in standard economic indicators as early as summer/fall 2006 (Mihm, 2008; Reinhart and Rogoff, 2008). Financial markets’ indicators would follow suit soon after with mild and sporadic warnings from index options.1 In this contribution we examine whether similar warning signals could be patterned in equity options markets (for options on individual stocks) in the UK. Specifically, we analyze the information efficiency of option IV as a predictor of (future) realized stocks downside volatility -a proxy for bank soundness and downside risk -of the four major UK banks around the 2008 global markets crash.2 Given that the event was mainly banking-driven, it is interesting to shed light on the interaction between banks’ stock prices and the volatilities implied by transactions prices for their exchange-listed options during the time leading to the crash.

Keywords: Option Price; Stochastic Volatility; Credit Default Swap; Imply Volatility; Downside Risk (search for similar items in EconPapers)
Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:pal:palchp:978-1-137-02509-8_9

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DOI: 10.1057/9781137025098_9

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