Variance Premium and Implied Volatility in a Low-Liquidity Option Market

Eduardo Astorino () and Fernando Chague, Bruno Cara Giovannetti, Marcos Eugênio da Silva
Authors registered in the RePEc Author Service: Bruno Cara Giovannetti and Fernando Chague

No 2015_08, Working Papers, Department of Economics from University of São Paulo (FEA-USP)

Abstract: We propose an implied volatility index for Brazil that we name "IVol-BR". The index is based on daily market prices of options over IBOVESPA -- an option market with relatively low liquidity and few option strikes. Our methodology combines standard international methodology used in high-liquidity markets with adjustments that take into account the low liquidity in Brazilian option markets. We then do a number of empirical tests to validate the IVol-BR. First, we show that the IVol-BR has significant predictive power over future volatility of equity returns not contained in traditional volatility forecasting variables. Second, we decompose the squared IVol-BR into (i) the expected variance of stock returns and (ii) the equity variance premium. This decomposition is of interest since the equity variance premium directly relates to the representative investor risk aversion. Finally, assuming Bollerslev et al. (2009) functional form, we produce a time-varying risk aversion measure for the Brazilian investor. We empirically show that risk aversion is positively related to expected returns, as theory suggests.

Keywords: IVol-BR; Variance Risk Premium; Risk-aversion (search for similar items in EconPapers)
JEL-codes: G12 G13 G17 (search for similar items in EconPapers)
Date: 2015-05-18
New Economics Papers: this item is included in nep-cfn, nep-fmk, nep-rmg and nep-upt
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Citations: View citations in EconPapers (1)

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Journal Article: Variance Premium and Implied Volatility in a Low-Liquidity Option Market (2017)
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