Skip to main content
SpringerLink
Log in

The 2008 UK Banking Crash: Evidence from Option Implied Volatility

  • Chapter
Advances in Financial Risk Management

  • 937 Accesses

Abstract

The 2007–9 Great Recession reached its culmination point in 15 September 2008 with the demise of Lehman Brothers and the near collapse of the global financial system. A major banking crash would follow as a result of impending stock markets mayhem and abnormal credit risk contagion (Bartram and Bodnar, 2009; Longstaff, 2010). UK banking institutions in particular were severely affected by this turn of events. The oligopolistic structure of the industry and the weight of financial services in the UK economy did not facilitate recovery expost. Although losses incurred were somewhat unpredictable, the crisis itself did not come as a surprise. Early signs for a global downturn looming could be spotted in standard economic indicators as early as summer/fall 2006 (Mihm, 2008; Reinhart and Rogoff, 2008). Financial markets’ indicators would follow suit soon after with mild and sporadic warnings from index options.1 In this contribution we examine whether similar warning signals could be patterned in equity options markets (for options on individual stocks) in the UK. Specifically, we analyze the information efficiency of option IV as a predictor of (future) realized stocks downside volatility -a proxy for bank soundness and downside risk -of the four major UK banks around the 2008 global markets crash.2 Given that the event was mainly banking-driven, it is interesting to shed light on the interaction between banks’ stock prices and the volatilities implied by transactions prices for their exchange-listed options during the time leading to the crash.

This is a preview of subscription content, log in via an institution to check access.

Access this chapter

Log in via an institution
Chapter
USD 29.95
Price excludes VAT (USA)
  • Available as PDF
  • Read on any device
  • Instant download
  • Own it forever
eBook
USD 84.99
Price excludes VAT (USA)
  • Available as EPUB and PDF
  • Read on any device
  • Instant download
  • Own it forever
Softcover Book
USD 109.99
Price excludes VAT (USA)
  • Compact, lightweight edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info
Hardcover Book
USD 109.99
Price excludes VAT (USA)
  • Durable hardcover edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info

Tax calculation will be finalised at checkout

Purchases are for personal use only

Institutional subscriptions

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

References

  • Barros, C. P., Managi, S. and Matousek, R. (2012). The Technical Efficiency of the Japanese Banks: Non-radial Directional Performance Measurement with Undesirable Output. Omega, 40 (1), 1–8.

    Article  Google Scholar 

  • Bartram, S. and Bodnar, G. M. (2009). No Place to Hide: The Global Crisis in Equity Markets in 2008/2009. Journal of International Money and Finance, 28 (8), 1246–92.

    Article  Google Scholar 

  • Bates, D. S. (1991). The Crash of ’87: Was It Expected? The Evidence from Options Markets. Journal of Finance, 46 (3), 1009–44.

    Article  Google Scholar 

  • Bates, D. S. (1996). Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutsche Mark Options. The Review of Financial Studies, 9 (1), 69–107.

    Article  Google Scholar 

  • Beckers, S. (1981). Standard Deviations Implied in Option Prices as Predictors of Future Stock Price Variability. Journal of Banking & Finance, 5 (3), 363–81.

    Article  Google Scholar 

  • Bhabra, G. S., Gonzalez, L., Kim, M. S. and Powell, J. G. (2001). Volatility Prediction during Prolonged Crises: Evidence from Korean Index Options. Pacific Basin Finance Journal, 9 (2), 147–64.

    Article  Google Scholar 

  • Birru, J. and Figlewski, S. (2012). Anatomy of a Meltdown: The Risk Neutral Density for the S&P 500 in the Fall of 2008. Journal of Financial Markets, 15 (2),151–80.

    Article  Google Scholar 

  • Black, F. and Scholes, M. (1973). The Pricing of Options and Corporate Liabilities. Journal of Political Economy, 81 (3), 637.

    Article  Google Scholar 

  • Cao, C., Li, H. and Yu, F. (2005). Is Investor Misreaction Economically Significant? Evidence from Short- and Long-term S&P 500 Index Options. Journal of Futures Markets, 25 (8), 717–52.

    Article  Google Scholar 

  • Cao, C., Yu, F. and Zhong, Z. (2010). The Information Content of Option-implied Volatility for Credit Default Swap Valuation. Journal of Financial Markets, 13 (3), 321–43.

    Article  Google Scholar 

  • Cao, C., Yu, F. and Zhong, Z. (2011). Pricing Credit Default Swaps with Option-Implied Volatility. Financial Analysts Journal, 67 (4), 67–76.

    Article  Google Scholar 

  • Cheng, L. T. W., Fung, J. K. W. and Chan, K. C. (2000). Pricing Dynamics of Index Options and Index Futures in Hong Kong Before and During the Asian Financial Crisis. Journal of Futures Markets, 20 (2), 145–66.

    Article  Google Scholar 

  • Christensen, B. J. and Prabhala, N. R. (1998). The Relation between Implied and Realized Volatility. Journal of Financial Economics, 50 (2), 125–50.

    Article  Google Scholar 

  • Crouhy, M. (2002). Comments on ‘Information about Bank Risk in Options Prices’. Journal of Banking & Finance, 26 (5), 1059–64.

    Article  Google Scholar 

  • Demyanyk, Y. and Hasan, I. (2010). Financial Crises and Bank Failures: A Review of Prediction Methods. Omega, 38 (5), 315–24.

    Article  Google Scholar 

  • Dietrich, A. and Wanzenried, G. (2011). Determinants of Bank Profitability before and during the Crisis: Evidence from Switzerland. Journal of International Financial Markets, Institutions and Money, 21 (3), 307–27.

    Article  Google Scholar 

  • Dupoyet, B. (2006). Information Content of Cross-Sectional Option Prices: A Comparison of Alternative Currency Option Pricing Models on the Japanese Yen. Journal of Futures Markets. 26 (1). 33–59.

    Article  Google Scholar 

  • Dwyer, G. P. and Tkac, P. (2009). The Financial Crisis of 2008 in Fixed-Income Markets. Journal of International Money and Finance, 28 (8), 1293–316.

    Article  Google Scholar 

  • Ederington, L. and Guan, W. (2005). The Information Frown in Option Prices. Journal of Banking & Finance, 29 (6), 1429–57.

    Article  Google Scholar 

  • Eichler, S., Karmann, A. and Maltritz, D. (2011). The Term Structure of Banking Crisis Risk in the United States: A Market Data Based Compound Option Approach. Journal of Banking & Finance, 35 (4), 876–85.

    Article  Google Scholar 

  • Elkamhi, R. and Ornthanalai, C. (2010). Market Jump Risk and the Price Structure of Individual Equity Options. Working Paper.

    Google Scholar 

  • Figlewski, S. (2009). Viewing the Financial Crisis from 20,000 Feet Up. Journal of Derivatives, 16 (3), 53–61.

    Article  Google Scholar 

  • Fung, J. K. W. (2007). The Information Content of Option Implied Volatility Surrounding the 1997 Hong Kong Stock Market Crash. Journal of Futures Markets, 27 (6), 555–74.

    Article  Google Scholar 

  • Gemmill, G. (1986). The Forecasting Performance of Stock Options on the London Traded Options Market. Journal of Business Finance & Accounting, 13 (4), 535–46.

    Article  Google Scholar 

  • Gemmill, G. (1992). Political Risk and Market Efficiency: Tests Based in British Stock and Options Markets in the 1987 Election. Journal of Banking & Finance, 16 (1), 211–31.

    Article  Google Scholar 

  • Gemmill, G. and Saflekos, A. (2000). How Useful are Implied Distributions? Evidence from Stock Index Options. The Journal of Derivatives, 7 (3), 83–91.

    Article  Google Scholar 

  • Hamalainen, P., Pop, A., Hall, M. and Howcroft, B. (2012). Did the Market Signal Impending Problems at Northern Rock? An Analysis of Four Financial Instruments. European Financial Management, 18 (1), 68–87.

    Article  Google Scholar 

  • Heston, S. L. (1993). A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options. Review of Financial Studies, 6 (2), 327.

    Article  Google Scholar 

  • Hull, J. and White, A. (1987). The Pricing of Options on Assets with Stochastic Volatilities. Journal of Finance, 42 (2), 281–300.

    Article  Google Scholar 

  • Ioannidis, C., Pasiouras, F. and Zopounidis, C. (2010). Assessing Bank Soundness with Classification Techniques. Omega, 38 (5), 345–57.

    Article  Google Scholar 

  • Jiang, G. J. and Tian, Y. S. (2005). The Model-Free Implied Volatility and Its Information Content. Review of Financial Studies, 18 (4), 1305–42.

    Article  Google Scholar 

  • Latane, H. A. and Rendleman Jr, R. J. (1976). Standard Deviations of Stock Price Ratios Implied in Option Prices. Journal of Finance, 31 (2), 369–81.

    Article  Google Scholar 

  • Liadaki, A. and Gaganis, C. (2010). Efficiency and Stock Performance of EU Banks: Is There a Relationship? Omega, 38 (5), 254–9.

    Article  Google Scholar 

  • Longstaff, F. A. (2010). The Subprime Credit Crisis and Contagion in Financial Markets. Journal of Financial Economics, 97 (3), 436–50.

    Article  Google Scholar 

  • Low, C. (2004). The Fear and Exuberance from Implied Volatility of S&P 100 Index Options. Journal of Business, 77 (3), 527–46.

    Article  Google Scholar 

  • Mayhew, S. (1995). Implied Volatility. Financial Analysts Journal, 51 (4), 8–20.

    Article  Google Scholar 

  • McIntyre, M. L. and Jackson, D. (2009). Market Moves and the Information Content of Option Prices. International Review of Economics & Finance, 18 (2), 327–40.

    Article  Google Scholar 

  • Merton, R. C. (1976). Option Pricing When Underlying Stock Returns Are Discontinuous. Journal of Financial Economics. 3(1–2), 125–44.

    Article  Google Scholar 

  • Mihm. S. (2008). Dr. Doom. The New York Times. New York.

    Google Scholar 

  • Mixon, S. (2009). Option Markets and Implied Volatility: Past versus Present. Journal of Financial Economics, 94 (2), 171–91.

    Article  Google Scholar 

  • Newey, W. and West, K. (1987). A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix. Econometrica, 55 (3), 703–8.

    Article  Google Scholar 

  • Poon, S.-H. and Granger, C. (2005). Practical Issues in Forecasting Volatility. Financial Analysts Journal, 61 (1), 45–56.

    Article  Google Scholar 

  • Poteshman, A. M. (2006). Unusual Option Market Activity and the Terrorist Attacks of September 11, (2001). Journal of Business, 79 (4), 1703–26.

    Article  Google Scholar 

  • Rappoport, P. and White, E. N. (1994). Was the Crash of 1929 Expected? American Economic Review, 84 (1), 271–81.

    Google Scholar 

  • Reinhart, C. M. and Rogoff, K. S. (2008). Is the 2007 US Sub-prime Financial Crisis So Different? An International Historical Comparison. American Economic Review, 98 (2), 339–44.

    Article  Google Scholar 

  • Spyrou, S. (2011). Are Broad Market Shocks Anticipated by Investors? Evidence from Major Equity and Index Options Markets. International Review of Financial Analysis, 20 (3), 127–33.

    Article  Google Scholar 

  • Swidler, S. and Wilcox, J. A. (2002). Information about Bank Risk in Options Prices. Journal of Banking and Finance, 26 (5), 1033–57.

    Article  Google Scholar 

  • Taylor, S. J., Yadav, P. K. and Zhang, Y. (2010). The Information Content of Implied Volatilities and Model-free Volatility Expectations: Evidence from Options Written on Individual Stocks. Journal of Banking & Finance, 34 (4), 871–81.

    Article  Google Scholar 

  • Trutwein, P. and Schiereck, D. (2011). The Fast and the Furious-Stock Returns and CDS of Financial Institutions under Stress. Journal of International Financial Markets, Institutions and Money, 21 (2), 157–75.

    Article  Google Scholar 

  • Xing, Y., Zhang, X. and Zhao, R. (2010). What Does the Individual Option Volatility Smirk Tell Us About Future Equity Returns? Journal of Financial and Quantitative Analysis, 45 (3), 641–62.

    Article  Google Scholar 

  • Yu, W. W., Lui, E. C. K. and Wang, J. W. (2010). The Predictive Power of the Implied Volatility of Options Traded OTC and on Exchanges. Journal of Banking & Finance, 34 (1), 1–11.

    Article  Google Scholar 

Download references

Authors
  1. Ha Yan Raymond So
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Tarik Driouchi
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Zhiyuan Simon Tan
    View author publications

    You can also search for this author in PubMed Google Scholar

Editor information

Editors and Affiliations

  1. Monash University, Melbourne, Australia

    Jonathan A. Batten

  2. Hong Kong University of Science and Technology, Hong Kong

    Peter MacKay

  3. Department of Business and Economics, University of Passau, Germany

    Niklas Wagner

Copyright information

© 2013 Ha Yan Raymond So, Tarik Driouchi, and Zhiyuan Simon Tan

About this chapter

Cite this chapter

So, H.Y.R., Driouchi, T., Tan, Z.S. (2013). The 2008 UK Banking Crash: Evidence from Option Implied Volatility. In: Batten, J.A., MacKay, P., Wagner, N. (eds) Advances in Financial Risk Management. Palgrave Macmillan, London. https://doi.org/10.1057/9781137025098_9

Download citation

Publish with us

Policies and ethics

Search

Navigation