Firm Fundamentals and the Cross Section of Implied Volatility Shapes
48 Pages Posted: 23 Jul 2020 Last revised: 2 Feb 2021
Date Written: June 30, 2020
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 all available US listed 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, especially for the volatility slopes and curvatures. 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: Suggested Citation