Firm Fundamentals and the Cross Section of Implied Volatility Shapes

45 Pages Posted: 23 Jul 2020

See all articles by Ding Chen

Ding Chen

University of Sussex Business School

Biao Guo

Renmin University of China

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School; China Academy of Financial Research (CAFR)

Date Written: June 30, 2020

Abstract

We investigate whether firm fundamentals can explain the shape of option implied volatility (IV) curve. Extending Geske's (1997) compound option model, we link firm fundamentals to the prices of equity and equity options, and show how the shape of IV curve can vary across firms with leverage, dividend policy, cost of capital, and so on. Using options of S&P 500 constituent companies, we show further empirically that firm fundamentals are important determinants of the IV curve even after controlling for historical volatility, risk-neutral skewness, kurtosis and systematic risk ratio. Fundamentals not only provide statistically and economically explanatory power on the IV curve, but also help reconcile with some stylized facts and puzzles.

Keywords: option implied volatility; volatility skew; firm fundamentals; option puzzle

JEL Classification: C11, C12, C13, G11, G12

Suggested Citation

Chen, Ding and Guo, Biao and Zhou, Guofu, Firm Fundamentals and the Cross Section of Implied Volatility Shapes (June 30, 2020). Available at SSRN: https://ssrn.com/abstract=3639312 or http://dx.doi.org/10.2139/ssrn.3639312

Ding Chen

University of Sussex Business School ( email )

214 Jubilee Building
University of Sussex
Brighton, Brighton BN1 9SL
United Kingdom

Biao Guo

Renmin University of China ( email )

Room B906
Xianjin Building
Beijing, Beijing 100872
China

Guofu Zhou (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

China Academy of Financial Research (CAFR)

Shanghai Advanced Institute of Finance
Shanghai P.R.China, 200030
China

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