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An analysis of implied volatility jump dynamics: Novel functional data representation in crude oil markets

Listed author(s):
  • Kearney, Fearghal
  • Murphy, Finbarr
  • Cummins, Mark

The predominant fear in capital markets is that of a price spike. Commodity markets differ in that there is a fear of both upward and down jumps, this results in implied volatility curves displaying distinct shapes when compared to equity markets. The use of a novel functional data analysis (FDA) approach, provides a framework to produce and interpret functional objects that characterise the underlying dynamics of oil future options. We use the FDA framework to examine implied volatility, jump risk, and pricing dynamics within crude oil markets. Examining a WTI crude oil sample for the 2007–2013 period, which includes the global financial crisis and the Arab Spring, strong evidence is found of converse jump dynamics during periods of demand and supply side weakness. This is used as a basis for an FDA-derived Merton (1976) jump diffusion optimised delta hedging strategy, which exhibits superior portfolio management results over traditional methods.

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File URL: http://www.sciencedirect.com/science/article/pii/S1062940815000455
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Article provided by Elsevier in its journal The North American Journal of Economics and Finance.

Volume (Year): 33 (2015)
Issue (Month): C ()
Pages: 199-216

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Handle: RePEc:eee:ecofin:v:33:y:2015:i:c:p:199-216
DOI: 10.1016/j.najef.2015.04.006
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620163

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