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The Informational Role of Option Trading Volume in Equity Index Options Markets

  • Ghulam Sarwar


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    This paper examines the dynamic relations between future price volatility of the S&P 500 index and trading volume of S&P 500 options to explore the informational role of option volume in predicting the price volatility. The future volatility of the index is approximated alternatively by implied volatility and by EGARCH volatility. Using a simultaneous equation model to capture the volume-volatility relations, the paper finds that strong contemporaneous feedbacks exist between the future price volatility and the trading volume of call and put options. Previous option volumes have a strong predictive ability with respect to the future price volatility. Similarly, lagged changes in volatility have a significant predictive power for option volume. Although the volume-volatility relations for individual volatility and volume terms are somewhat different under the two volatility measures, the results on the predictive ability of volume (volatility) for volatility (volume) are broadly similar between the implied and EGARCH volatilities. These findings support the hypothesis that both the information- and hedge-related trading explain most of the trading volume of equity index options. Copyright Springer Science + Business Media, Inc. 2005

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    Article provided by Springer in its journal Review of Quantitative Finance and Accounting.

    Volume (Year): 24 (2005)
    Issue (Month): 2 (January)
    Pages: 159-176

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    Handle: RePEc:kap:rqfnac:v:24:y:2005:i:2:p:159-176
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    1. Mayhew, Stewart & Sarin, Atulya & Shastri, Kuldeep, 1995. " The Allocation of Informed Trading across Related Markets: An Analysis of the Impact of Changes in Equity-Option Margin Requirements," Journal of Finance, American Finance Association, vol. 50(5), pages 1635-53, December.
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    7. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
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