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Do liquidity and sampling methods matter in constructing volatility indices? Empirical evidence from Taiwan

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  • Tzang, Shyh-Weir
  • Hung, Chih-Hsing
  • Wang, Chou-Wen
  • Shyu, David So-De
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    Abstract

    This paper proposes four methods by which to sample option prices using proxies for liquidity--1-, 2-, 3-, 7-, and 8-day rollover rules--for option trades in order to construct volatility index series. Based on the sampling method using the average of all midpoints of bid and ask quote option prices, the volatility indices constructed by one-minute tick data have less missing data and are at least as efficient in volatility forecasting as the method suggested by the CBOE. In addition, based on different rollover rules, illiquidity in Taiwan's options market does not lead to substantial errors in the forecasting effectiveness of the volatility indices. Finally, the forecasting ability of VIX based on different sampling methods is found to be superior to that of VXO in Taiwan.

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    Bibliographic Info

    Article provided by Elsevier in its journal International Review of Economics & Finance.

    Volume (Year): 20 (2011)
    Issue (Month): 2 (April)
    Pages: 312-324

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    Handle: RePEc:eee:reveco:v:20:y:2011:i:2:p:312-324

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    Web page: http://www.elsevier.com/locate/inca/620165

    Related research

    Keywords: VIX VXO Sampling method Rollover rules Implied volatility Index options Taiwan Stock Exchange Index (TAIEX) options;

    References

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    1. Beckers, Stan, 1981. "Standard deviations implied in option prices as predictors of future stock price variability," Journal of Banking & Finance, Elsevier, vol. 5(3), pages 363-381, September.
    2. Bent Jesper Christensen & Charlotte Strunk Hansen, 2002. "New evidence on the implied-realized volatility relation," The European Journal of Finance, Taylor & Francis Journals, vol. 8(2), pages 187-205, June.
    3. Canina, Linda & Figlewski, Stephen, 1993. "The Informational Content of Implied Volatility," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 659-81.
    4. Torben G. Andersen & Oleg Bondarenko, 2007. "Construction and Interpretation of Model-Free Implied Volatility," CREATES Research Papers 2007-24, School of Economics and Management, University of Aarhus.
    5. Latane, Henry A & Rendleman, Richard J, Jr, 1976. "Standard Deviations of Stock Price Ratios Implied in Option Prices," Journal of Finance, American Finance Association, vol. 31(2), pages 369-81, May.
    6. Chiras, Donald P. & Manaster, Steven, 1978. "The information content of option prices and a test of market efficiency," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 213-234.
    7. Lamoureux, Christopher G & Lastrapes, William D, 1993. "Forecasting Stock-Return Variance: Toward an Understanding of Stochastic Implied Volatilities," Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 293-326.
    8. Blair, Bevan J. & Poon, Ser-Huang & Taylor, Stephen J., 2001. "Forecasting S&P 100 volatility: the incremental information content of implied volatilities and high-frequency index returns," Journal of Econometrics, Elsevier, vol. 105(1), pages 5-26, November.
    9. Day, Theodore E. & Lewis, Craig M., 1988. "The behavior of the volatility implicit in the prices of stock index options," Journal of Financial Economics, Elsevier, vol. 22(1), pages 103-122, October.
    10. Jorion, Philippe, 1995. " Predicting Volatility in the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 50(2), pages 507-28, June.
    11. Mark Britten-Jones & Anthony Neuberger, 2000. "Option Prices, Implied Price Processes, and Stochastic Volatility," Journal of Finance, American Finance Association, vol. 55(2), pages 839-866, 04.
    12. Parkinson, Michael, 1980. "The Extreme Value Method for Estimating the Variance of the Rate of Return," The Journal of Business, University of Chicago Press, vol. 53(1), pages 61-65, January.
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    Cited by:
    1. Kao, Erin H. & Fung, Hung-Gay, 2012. "Intraday trading activities and volatility in round-the-clock futures markets," International Review of Economics & Finance, Elsevier, vol. 21(1), pages 195-209.

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