The Implied Volatility of Option Prices: A Test Using Options on UK Stocks
University of Lancaster Working Paper No. 95/004
Posted: 10 Oct 1998
Date Written: May 1995
This paper presents and tests a model of the volatility of individual company stocks derived from option prices. The data comes from 63 traded options quoted on the London International Financial Futures Exchange. The model relates volatilities to earnings announcement dates, interest rate volatility and to accounting variables representing leverage, the degree of fixed rate debt, asset duration and earnings inflation indexation. The model predicts that volatility is positively related to duration and leverage and negatively related to both the degree of inflation indexation and the proportion of fixed rate debt in the capital structure. Empirical results suggest that duration and inflation indexation are significant determinants of the implied volatility. Time series test also show an expected drop in volatility after the earnings announcement date and in most cases a positive relationship between the implied volatility of the stock and the volatility of interest rates.
JEL Classification: G14, G39
Suggested Citation: Suggested Citation