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Credit‐Implied Equity Volatility—Long‐Term Forecasts and Alternative Fear Gauges

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  • Hans Byström

Abstract

This study discusses how to compute and forecast long‐term stock return volatilities, typically with a five‐year horizon or longer, using credit derivatives, and how such volatilities can be used in different areas ranging from the valuation of employee stock options and other long‐term derivatives to the construction of market‐based fear gauges in selected countries or market segments. In the empirical part of the paper I focus on the European financial sector and find the credit‐implied volatilities and fear gauges to behave well. The forecasting accuracy of the credit‐implied volatilities is found to be better than that of horizon‐matched historical volatilities. © 2014 The Authors. Journal of Futures Markets Published by Wiley Periodicals, Inc. Jrl Fut Mark 35:753–775, 2015

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  • Hans Byström, 2015. "Credit‐Implied Equity Volatility—Long‐Term Forecasts and Alternative Fear Gauges," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 35(8), pages 753-775, August.
  • Handle: RePEc:wly:jfutmk:v:35:y:2015:i:8:p:753-775
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    1. Jiang, George J. & Tian, Yisong S., 2010. "Forecasting Volatility Using Long Memory and Comovements: An Application to Option Valuation under SFAS 123R," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(2), pages 503-533, April.
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    3. repec:ecb:ecbwps:20111426 is not listed on IDEAS
    4. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
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    6. Ser-Huang Poon & Clive W.J. Granger, 2003. "Forecasting Volatility in Financial Markets: A Review," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 478-539, June.
    7. Byström, Hans, 2013. "Stock Prices and Stock Return Volatilities Implied by the Credit Market," Working Papers 2013:25, Lund University, Department of Economics, revised 14 Feb 2014.
    8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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