Option implied ambiguity and its information content: Evidence from the subprime crisis
Date
2018ISSN
1572-9338Source
Annals of Operations ResearchVolume
262Issue
2Pages
463-491Google Scholar check
Metadata
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This paper studies option investors’ tendency to deviate from risk-neutrality around extreme financial events. We incorporate ambiguity into Black–Scholes theory and analyze the lead–lag association between option and stock markets during 2006–2008. Our findings from the Standard and Poor’s 500 index options reveal that investors’ option implied ambiguity moderates the lead–lag relationship between implied and realized volatility. We find that implied ambiguity contains predictive realized volatility information (beyond constant and stochastic implied volatilities), and that implied volatility is a less biased predictor of realized market variance when accounting for ambiguity in option pricing. We are also able to track changing investors’ ambiguity perceptions (pessimism or optimism) prior to severe volatility events and document shifts in ambiguity aversion among put option holders in the period leading to the fall 2008 global market crash. Our results hold under multiple-priors and Choquet ambiguity specifications.