✦ LIBER ✦

A random walk down the options market

✍ Scribed by George J. Jiang; Yisong S. Tian

Publisher: John Wiley and Sons
Year: 2011
Tongue: English
Weight: 399 KB
Volume: 32
Category: Article
ISSN: 0270-7314
DOI: 10.1002/fut.20528

No coin nor oath required. For personal study only.

✦ Synopsis

Under the efficient market hypothesis, option-implied forward variance forms a martingale and changes in forward variance follow a random walk. In this study, we extract forward variance from option prices following a model-free approach and empirically test the random walk hypothesis. Although results from standard orthogonality tests support the martingale restriction, further results from autoregressive regressions seem to reject the martingale restriction as daily changes in forward variance are found to exhibit negative autocorrelation. However, this anomalous pattern of negative correlation is fully explained by illiquidity effects. Overall, the findings support the random walk hypothesis and informational efficiency of the options market.

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