Vähämaa, Sami (2004). Essays on option-implied information. Acta
Wasaensia No. 131, 137 p.
This thesis focuses on information implied by option prices. In
particular, the purpose of the thesis is to examine the behaviour of
option-implied information and to apply this information to risk management of
options. The thesis consists of an introductory chapter and four essays. The
first essay of the thesis is motivated by the inverse movements between
volatility and stock prices and its implications for delta hedging of stock
index options. In this essay, the implied volatility smile is utilised for
adjusting the Black-Scholes (1973) delta to account for the inverse
relationship between volatility changes and stock returns. The results of the
essay show that the smile-adjusted delta consistently leads to smaller hedging
errors than the Black-Scholes delta, thereby demonstrating the importance of the inverse volatility and stock price movements for risk management of options. The second essay of the thesis focuses on the
effects of non-Gaussian return distributions on delta hedging of stock index
options. In this essay, option-implied probability distributions are applied to
develop a skewness and kurtosis adjusted hedge ratio. The empirical results of
the essay indicate that the skewness and kurtosis adjusted model performs worse
than the simplistic Black-Scholes (1973) model in terms of delta hedging. The
third essay of the thesis examines the behaviour of option-implied asymmetries
in bond market expectations around monetary
policy actions of the European Central Bank (ECB). In this essay,
option-implied probability distributions are used to assess the asymmetries in
bond market expectations. The empirical findings reported in the essay
show that the bond market expectations
are systematically asymmetric around monetary policy actions of the ECB.
Furthermore, the results indicate that the bond market expectations are
significantly altered around monetary policy actions, as the asymmetries in
market expectations tend to increase before changes in the monetary policy
stance, and to decrease afterwards. Finally, the
fourth essay of the thesis examines the cross-dynamics of option-implied
volatilities across major European currencies. The results provided in this
essay demonstrate that the market expectations of future exchange rate
volatilities are closely linked among major European currencies.
Sami Vähämaa, Graduate School of Finance and Financial Accounting,
Department of Accounting and Finance, University of Vaasa, P.O. Box 700,
FIN-65101 Vaasa, Finland.
Key words: Option-implied information, implied volatility,
implied skewness, implied asymmetries, implied probability distributions, risk
management, delta hedging