Relative Implied Volatility Arbitrage and the Joint-Efficiency of Index Options Markets

Posted: 15 Feb 2006 Last revised: 19 Feb 2008

Date Written: September 1, 2004

Abstract

It is the intention of this paper to examine the joint-efficiency of equity index options markets by testing for potential profit opportunities generated from high-frequency trading of the implied volatility spread between equity markets whose volatilities are highly correlated. Our enquiry is motivated by the results of a substantial body of literature which demonstrates the strong degree of volatility linkages across global asset markets.

Using the FTSE and DAX equity option index markets, we find evidence of abnormal returns, after transaction costs, and are then able to trace the source of these returns to explanatory factors which include contemporaneous trading volume and lagged returns. Our results suggest that the two options markets are not jointly efficient. Implications for multivariate risk estimation and volatility spillover modeling are also reported.

Keywords: implied volatility, arbitrage, options

JEL Classification: C00, C50, C53, G13, G14

Suggested Citation

Veselinovich, Boris, Relative Implied Volatility Arbitrage and the Joint-Efficiency of Index Options Markets (September 1, 2004). Available at SSRN: https://ssrn.com/abstract=881550

Boris Veselinovich (Contact Author)

Mondrian Investment Partners ( email )

80 Cheapside
London, EC2V 6EE
United Kingdom

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