An Analysis of Implied Volatility Jump Dynamics: Novel Functional Data Representation in Crude Oil Markets

North American Journal of Economics and Finance, Forthcoming

Posted: 19 Apr 2015

See all articles by Fearghal Kearney

Fearghal Kearney

Queen's University Belfast - Queen's Management School

Finbarr Murphy

University of Limerick - Kemmy Business School

Mark Cummins

Dublin City University Business School

Date Written: April 17, 2015

Abstract

The predominant fear in capital markets is that of a price spike. Commodity markets differ in that there is a fear of both upward and down jumps, this results in implied volatility curves displaying distinct shapes when compared to equity markets. The use of a novel functional data analysis (FDA) approach, provides a framework to produce and interpret functional objects that characterise the underlying dynamics of oil future options. We use the FDA framework to examine implied volatility, jump risk, and pricing dynamics within crude oil markets. Examining a WTI crude oil sample for the 2007-2013 period, which includes the global financial crisis and the Arab Spring, strong evidence is found of converse jump dynamics during periods of demand and supply side weakness. This is used as a basis for an FDA-derived Merton (1976) jump diffusion optimised delta hedging strategy, which exhibits superior portfolio management results over traditional methods.

Keywords: Commodity options, Implied volatility, Jump diffusion models, Functional data analysis.

JEL Classification: C50, C58, G11, G12

Suggested Citation

Kearney, Fearghal and Murphy, Finbarr and Cummins, Mark, An Analysis of Implied Volatility Jump Dynamics: Novel Functional Data Representation in Crude Oil Markets (April 17, 2015). North American Journal of Economics and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2595706

Fearghal Kearney (Contact Author)

Queen's University Belfast - Queen's Management School ( email )

Riddel Hall
185 Stranmillis Road
Belfast, BT9 5EE
United Kingdom

Finbarr Murphy

University of Limerick - Kemmy Business School ( email )

Limerick
Ireland

Mark Cummins

Dublin City University Business School ( email )

Dublin 9
Ireland

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