Lessons from Estimating the Average Option-implied Volatility Term Structure for the Spanish Banking Sector

40 Pages Posted: 3 Sep 2021

Date Written: September 2, 2021

Abstract

This paper estimates the volatility index term structure for the Spanish bank industry (SBVX) using the implied volatility of individual banks and assuming market correlation risk premium. This methodology enables calculating a volatility index for arbitrary (non-traded) portfolios. Using data from 2015 to 2021, we find that SBVX informs about the dynamics of bank returns beyond the standard market volatility index VIBEX, especially when bank returns are negative; and that one-year SBVX beats shorter maturities in explaining bank returns. On the other hand, positive bank returns relate to the dynamics of VIBEX just as much as SBVX, which aligns with the belief that a drop in global volatility (uncertainty) positively affects firm performance and, therefore, bank value projections. We find one-month SBVX better than VIBEX to forecast monthly bank returns volatility, regardless of the tenor we use to compute VIBEX. This paper provides empirical evidence that idiosyncratic implied volatility is just as significant, or even more than global volatility, to monitor current and future banks’ share price performance. We advise using SBVX term structure, short-term VIBEX, and market correlation risk premium to monitor uncertainty and returns in the banking sector and foresee periods of stress in this industry. Our results may be of great interest to those seeking to estimate the banking sector’s sensitivity to uncertainty, volatility, and risk.

Keywords: volatility term-structure, implied volatility, risk

JEL Classification: G53, G1

Suggested Citation

Gonzalez-Perez, Maria T., Lessons from Estimating the Average Option-implied Volatility Term Structure for the Spanish Banking Sector (September 2, 2021). Banco de Espana Working Paper No. 2128, Available at SSRN: https://ssrn.com/abstract=3916164 or http://dx.doi.org/10.2139/ssrn.3916164

Maria T. Gonzalez-Perez (Contact Author)

Bank of Spain ( email )

Calle Alcala, 48
Madrid, 28014
Spain
+34 913388587 (Phone)

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