Investors' and Central Bank's Uncertainty Embedded in Index Options

Alexander David and Pietro Veronesi

No 16764, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Shocks to equity options' ATM implied volatility (ATMIV) are followed by persistently lower short-term rates. Shocks to the ratio of OTM puts' over OTM calls' implied volatilities (P/C) are followed by persistently higher rates. The stock's and Treasury-bond's ATMIV indices, which measure market and policy uncertainty, are counter-cyclical while the P/C index, which measures downside risk, is pro-cyclical. An equilibrium model where investors and the central bank learn about composite regimes on economic and policy variables explains these options' dynamics, linking them to a learning-based, forward-looking Taylor rule. The model produces several predictions on the relation between options, monetary policy variables, and beliefs that find support in the data.

JEL-codes: G12 G13 G18 (search for similar items in EconPapers)
Date: 2011-02
Note: AP EFG ME
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Published as Alexander David & Pietro Veronesi, 2014. "Investors' and Central Bank's Uncertainty Embedded in Index Options," Review of Financial Studies, vol 27(6), pages 1661-1716.

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