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The Informational Role of Asset Prices: The Case of Implied Volatility

Working Paper 95-063

Posted: 25 Aug 1998  

Zvi Bodie

Boston University - Department of Finance & Economics

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Harvard Business School - Finance Unit

Abstract

An important function of the financial system is to serve as a key source of information that helps coordinate decentralized decision-making in various sectors of the economy. Households and investors use interest rates, futures prices and security prices in making their consumption-saving decisions and portfolio allocation decisions. Interest rates and prices provide important signals to managers of firms in their selection of investment projects and financings. This paper illustrates the role played by financial markets in providing information about the future volatility-that is, the degree of uncertainty-of economic variables such as interest rates, exchange rates, commodity prices, and stock, bond and other security prices. It has two basic goals: (1) to show the importance of volatility for all sorts of policy decisions in the private and public sectors of the economy; and (2) to show how ex ante estimates of future volatility can be extracted from the prices of securities.

JEL Classification: G12, G14

Suggested Citation

Bodie, Zvi and Merton, Robert C., The Informational Role of Asset Prices: The Case of Implied Volatility. Working Paper 95-063. Available at SSRN: https://ssrn.com/abstract=6568

Zvi Bodie (Contact Author)

Boston University - Department of Finance & Economics ( email )

United States

HOME PAGE: http://www.zvibodie.com

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Avenue
E62-634
Cambridge, MA 02139-4307
United States
617 715 4866 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6678 (Phone)

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