A Random Walk Down the Options Market

Journal of Futures Markets, 2012, 32(6), 505-535.

31 Pages Posted: 22 Mar 2009 Last revised: 3 Oct 2012

See all articles by George J. Jiang

George J. Jiang

Washington State University

Yisong S. Tian

York University - Schulich School of Business

Date Written: February 26, 2012


Under efficient market hypothesis, option-implied forward variance forms a martingale and changes in forward variance follow a random walk. In this paper, we extract forward variance from option prices following a model-free approach and empirically test the random walk hypothesis. Although results from standard orthogonality tests support the martingale restriction, further results from autoregressive regressions seem to reject the martingale restriction as daily changes in forward variance are found to exhibit negative autocorrelation. However, this anomalous pattern of negative correlation is fully explained by illiquidity effects. Overall, the findings support the random walk hypothesis and informational efficiency of the options market.

Keywords: Model-free forward variance, random walk, expectations hypothesis, market illiquidity, model misspecification

JEL Classification: G13, G14

Suggested Citation

Jiang, George and Tian, Yisong Sam, A Random Walk Down the Options Market (February 26, 2012). Journal of Futures Markets, 2012, 32(6), 505-535.. Available at SSRN: https://ssrn.com/abstract=1364524

George Jiang

Washington State University ( email )

Department of Finance and Management Science
Carson College of Business
Pullman, WA 99-4746164
United States
509-3354474 (Phone)

HOME PAGE: http://directory.business.wsu.edu/bio.html?username=george.jiang

Yisong Sam Tian (Contact Author)

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
416-736-2100, ext 77943 (Phone)
416-736-5687 (Fax)

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