Expectations Hypothesis of the Term Structure of Implied Volatility: Evidence from Foreign Currency and Stock Index Options

Posted: 29 Feb 2008

See all articles by Soku Byoun

Soku Byoun

Baylor University

Chuck C.Y. Kwok

University of South Carolina - Darla Moore School of Business

Hun Y. Park

University of Illinois at Urbana-Champaign - Department of Finance

Abstract

Using a stochastic volatility option pricing model, we show that the implied volatilities of at-the-money options are not necessarily unbiased and that the fixed interval time-series can produce misleading results. Our results do not support the expectations hypothesis: long-term volatilities rise relative to short-term volatilities, but the increases are not matched as predicted by the expectations hypothesis. In addition, an increase in the current long-term volatility relative to the current short-term volatility is followed by a subsequent decline. The results are similar for both foreign currency and the S&P 500 stock index options.

Keywords: expectations hypothesis, implied volatility, stochastic volatility, term structure

Suggested Citation

Byoun, Soku and Kwok, Chuck C.Y. and Park, Hun Y., Expectations Hypothesis of the Term Structure of Implied Volatility: Evidence from Foreign Currency and Stock Index Options. Journal of Financial Econometrics, Vol. 1, No. 1, pp. 126-151, 2003. Available at SSRN: https://ssrn.com/abstract=821694

Soku Byoun (Contact Author)

Baylor University ( email )

Department of Finance Insurance & Real Estate
P.O.Box 98004
Waco, TX 76712
254-710-7849 (Phone)

Chuck C.Y. Kwok (Contact Author)

University of South Carolina - Darla Moore School of Business ( email )

1705 College St
Francis M. Hipp Building
Columbia, SC 29208
United States
803-777-3606 (Phone)
803-777-3609 (Fax)

Hun Y. Park (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Urbana, IL 61820
United States
217-333-0659 (Phone)
217-244-3102 (Fax)

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