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Article

Impact of Net Buying Pressure on Changes in Implied Volatility: Before and After the Onset of the Subprime Crisis

Yung-Ming Shiu, Ging-Ginq Pan, Shu-Hui Lin and Tu-Cheng Wu
The Journal of Derivatives Summer 2010, 17 (4) 54-66; DOI: https://doi.org/10.3905/jod.2010.17.4.054
Yung-Ming Shiu
is an associate professor in the Department of Business Administration at National Cheng Kung University in Tainan, Taiwan.
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  • For correspondence: yungming@mail.ncku.edu.tw
Ging-Ginq Pan
is an associate professor at the Graduate Institute of Finance, National Pingtung University of Science and Technology, in Pingtung, Taiwan.
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  • For correspondence: ggpam@mail.npust.edu.tw
Shu-Hui Lin
is an assistant professor in the Department of Business Education at National Changhua University of Education in Changhua, Taiwan.
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  • For correspondence: shlin@cc.ncue.edu.tw
Tu-Cheng Wu
is an associate professor in the Department of Applied Mathematics at I-Shou University in Dashu, Taiwan.
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  • For correspondence: tucheng@isu.edu.tw
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Abstract

In the Black–Scholes (BS) framework and valuation model, asset returns follow a lognormal diffusion and volatility is a constant parameter. In such a world, implied volatility is equal to the true volatility and is the same for options of all strikes. But, as everyone knows, the volatility “smile” in the real world stands as a serious contradiction to pure Black–Scholes. What causes the smile, and why does it change shape periodically? One set of possible answers to these important questions comes from modifying the BS assumptions, for example, by allowing stochastic volatility or non-lognormal fat-tailed return distributions. Another potential explanation is that the smile, and especially its dynamics, reflects imbalances in option demand and supply within the market population. A serious market shock can provide valuable insight into this question by revealing how implied volatilities respond to market events in times of stress. In this article, Shiu, Pan, Lin, and Wu explore the demand imbalance explanation as it applies to the TAIEX index of Taiwan stocks before and during the financial crisis of 2008. They find strong evidence that demand pressure does affect the implied volatility surface, but unlike in the U.S., the nature of the influence is more concentrated in calls than in puts.

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The Journal of Derivatives: 17 (4)
The Journal of Derivatives
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Summer 2010
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Impact of Net Buying Pressure on Changes in Implied Volatility: Before and After the Onset of the Subprime Crisis
Yung-Ming Shiu, Ging-Ginq Pan, Shu-Hui Lin, Tu-Cheng Wu
The Journal of Derivatives May 2010, 17 (4) 54-66; DOI: 10.3905/jod.2010.17.4.054

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Impact of Net Buying Pressure on Changes in Implied Volatility: Before and After the Onset of the Subprime Crisis
Yung-Ming Shiu, Ging-Ginq Pan, Shu-Hui Lin, Tu-Cheng Wu
The Journal of Derivatives May 2010, 17 (4) 54-66; DOI: 10.3905/jod.2010.17.4.054
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  • Article
    • Abstract
    • THE MODEL AND DATA
    • MONEYNESS CATEGORY
    • IMPLIED VOLATILITY CURVE
    • NET BUYING PRESSURE
    • REGRESSION ANALYSIS
    • CONCLUSION
    • REFERENCES
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