Misreaction or Misspecification? A Re-Examination of Volatility Anomalies

12 Pages Posted: 22 Aug 2011 Last revised: 20 Feb 2013

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 16, 2010

Abstract

Existing research examines the impact of volatility shocks on the relative pricing of long-term vs. short-term options and documents patterns of short-horizon underreaction and long-horizon overreaction in the options market. These studies, however, rely on implied volatilities derived from specific option pricing models and are thus subject to model specification errors. In this paper, we show that these anomalous patterns are the result of model misspecification as opposed to market misreaction. We provide evidence that these patterns are consistent with, in both direction and magnitude, inherent biases in the misspecified models. We also apply a model-free approach to re-examine the anomalous patterns and find no evidence of market misreaction.

Keywords: Volatility anomaly, Model misspecification, Market misreaction, Model-free implied volatility, Market efficiency

JEL Classification: G13, G14

Suggested Citation

Jiang, George and Tian, Yisong Sam, Misreaction or Misspecification? A Re-Examination of Volatility Anomalies (February 16, 2010). Journal of Banking and Finance, Vol. 34, 2010. Available at SSRN: https://ssrn.com/abstract=1913753

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
Canada
416-736-2100, ext 77943 (Phone)
416-736-5687 (Fax)

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