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Do the options markets really overreact?

Do the options markets really overreact? n a recent article, Stein (1989) derives and tests a model that describes the relationship between implied volatilities on options of different maturities. Under the assumption that volatility follows a mean-reverting process with a constant Iong-run mean and a constant coefficient of mean reversion, it is shown that for a given change in the implied volatility of a short maturity option, there should be a smaller change in the implied volatility of a longer maturity option. Stein also conducts tests of his model using a sample of S&P 100 (OEX) options and concludes that long-term volatilities overreact to changes in short-term volatilities in a manner that is inconsistent with the predictions of his model. This article identifies some problems associated with the above mentioned empirical tests, and conducts an alternate set of tests. The results provide no indication of overreaction in the market for index options. The following section provides a summary of Stein's mean reverting volatility model and tests. The third section contains an alternate set of tests of the overreactions hypothesis and a description of the data used in this study, and the fourth section presents the results of the tests. The final section contains conclusions http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Futures Markets Wiley

Do the options markets really overreact?

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References (17)

Publisher
Wiley
Copyright
Copyright © 1993 Wiley Periodicals, Inc., A Wiley Company
ISSN
0270-7314
eISSN
1096-9934
DOI
10.1002/fut.3990130306
Publisher site
See Article on Publisher Site

Abstract

n a recent article, Stein (1989) derives and tests a model that describes the relationship between implied volatilities on options of different maturities. Under the assumption that volatility follows a mean-reverting process with a constant Iong-run mean and a constant coefficient of mean reversion, it is shown that for a given change in the implied volatility of a short maturity option, there should be a smaller change in the implied volatility of a longer maturity option. Stein also conducts tests of his model using a sample of S&P 100 (OEX) options and concludes that long-term volatilities overreact to changes in short-term volatilities in a manner that is inconsistent with the predictions of his model. This article identifies some problems associated with the above mentioned empirical tests, and conducts an alternate set of tests. The results provide no indication of overreaction in the market for index options. The following section provides a summary of Stein's mean reverting volatility model and tests. The third section contains an alternate set of tests of the overreactions hypothesis and a description of the data used in this study, and the fourth section presents the results of the tests. The final section contains conclusions

Journal

The Journal of Futures Markets – Wiley

Published: May 1, 1993

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