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Annals of Operations Research

, Volume 262, Issue 2, pp 463–491 | Cite as

Option implied ambiguity and its information content: Evidence from the subprime crisis

  • Tarik DriouchiEmail author
  • Lenos Trigeorgis
  • Raymond H. Y. So
S.I.: Financial Economics

Abstract

This paper studies option investors’ tendency to deviate from risk-neutrality around extreme financial events. We incorporate ambiguity into Black–Scholes theory and analyze the lead–lag association between option and stock markets during 2006–2008. Our findings from the Standard and Poor’s 500 index options reveal that investors’ option implied ambiguity moderates the lead–lag relationship between implied and realized volatility. We find that implied ambiguity contains predictive realized volatility information (beyond constant and stochastic implied volatilities), and that implied volatility is a less biased predictor of realized market variance when accounting for ambiguity in option pricing. We are also able to track changing investors’ ambiguity perceptions (pessimism or optimism) prior to severe volatility events and document shifts in ambiguity aversion among put option holders in the period leading to the fall 2008 global market crash. Our results hold under multiple-priors and Choquet ambiguity specifications.

Keywords

Choquet utility Multiple-priors Option implied ambiguity Implied volatility Realized volatility Uncertainty 

Abbreviations

BS

Black–Scholes

BSIV

Black–Scholes risk-neutral implied volatility

BSIV \(\times \) IC

Interaction between BSIV and IC

CBOE

Chicago board options exchange

CDS

Credit default swaps

CEU

Choquet expected utility

IC

Option implied ambiguity

ICBSIV

Ambiguity-adjusted implied volatility (BSIV \(\times \) IC)

II

Investors intelligence

IV

Implied volatility

\(\hbox {IV}_{\mathrm{c}}\)

Ambiguity-based implied volatility

MEU

Multiple-priors expected utility

NW

Newey–West

OTM

Out of the money

RV

Realized volatility

\(\hbox {s} \times \hbox {BSIV}\)

Choquet-based implied volatility

SPX

S&P 500 index options

SV

Stochastic volatility

\(\hbox {SV} \times \hbox {IC}\)

Interaction between SV and IC

VIX

CBOE implied volatility index

Notes

Acknowledgments

We thank the editors and the anonymous referees for their constructive comments and suggestions. Thanks are also due to Richard Arnott, Mark Clatworthy, Colin Clubb, Paul Guest, George Nishiotis, and Rafal Wojakowski for their helpful comments on earlier versions of this work. The author Lenos Trigeorgis is the Bank of Cyprus Chair Professor of Finance at the University of Cyprus.

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Copyright information

© Springer Science+Business Media New York 2015

Authors and Affiliations

  • Tarik Driouchi
    • 1
    Email author
  • Lenos Trigeorgis
    • 2
  • Raymond H. Y. So
    • 1
  1. 1.Department of Management, King’s College LondonUniversity of LondonLondonUK
  2. 2.Department of Accounting and FinanceUniversity of CyprusNicosiaCyprus

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