The relationship between the volatilities of the S&P 500 index and futures contracts implicit in their call option prices

✍ Scribed by Li-Ming Han; Lalatendu Misra

• Publisher: John Wiley and Sons
• Year: 1990
• Tongue: English
• Weight: 743 KB
• Volume: 10
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.3990100306

✦ Synopsis

he volatility of the stock market is a matter of great concern to investors. The high T level of market volatility has attracted regulatory attention since the crash of October 19, 1987. The stock market is believed to be more volatile now than it has been in the past. Investor surveys conducted after the crash suggest that the increased volatility of the market and the ensuing loss of investor confidence has caused many investors to stay out of the market.' Some recent estimates of market volatility are based on inter-day price movement.* Volatility measures that take into account the long-term future prospects of the market are desirable measures from the perspective of long-term investors.

Volatility as contained implicitly in the prices of options on a market index provides one measure of anticipated variability of market returns for the longer term. Such a volatility measure incorporates the ex-ante estimates of market participants and is therefore a valuable indicator of expected variability. In an analogous manner, stock index futures options provide a means of measuring market participants' ex-unfe assessment regarding average volatility of futures prices changes on a daily bask3

The implicit volatility of the market index is analyzed in a number of recent studies. Poterba and Summers (1986) analyze whether or not volatility changes persist for the implied volatility of the S&P 500 index. They conclude that the effect of shocks are not persistent. Much of the observed variation in stock prices is therefore due to factors other than fluctuating risk premia brought about by volatility changes. Franks and Schwartz (1988) investigate the impact of variables such as corporate leverage, trading

We wish to thank Keith Fairchild and two reviewers of this Journal for their many helpful comments. We are responsible for all the remaining errors. Misra's research was supported in part by a research grant from the Dean, College of Business at UTSA. 'See Power (1988). Edwards (1988) also points out that increased volatility results in a loss of investor confidence.

'Edwards (1988) computes the daily close-to-close volatility and high-low volatility of the market index. Grossman (1988) conducts a study of market volatility and trading volume. He uses different measures of inter-day price movement and finds no relationship between volatility and volume.

T h e volatility of index return is subsequently referred to as volatility of the index. Similarly, the volatility of index futures price changes is referred to as the volatility of the index futures.