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Are Volatility Expectations in Different Countries Interdependent-

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Are Volatility Expectations in Different Countries Interdependent-

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-to Structural VAR Identification for Implied Equity Volatility IndicesTimothy de SilvaClaremont McKenna College, tdesilval8@cmc.eduFollow this and add

itional works at: https://digitalcoinnions.iwu.edu/uerPart of the Econometrics Commons, and the Finance CommonsRecommended Citationde Silva, Timothy ( Are Volatility Expectations in Different Countries Interdependent-

2017) "Are Volatility Expectations in Different Countries Intel-dependent? A Data-Driven Solution to structural VAR Identification for Implied Equity

Are Volatility Expectations in Different Countries Interdependent-

Volatility Indices," Undergraduate Economic Review: Vol. 14 : Iss. 1 , Article 8.Available at: https://digitalcommons.iwu.edU/uer/voll4/issl/8This Art

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-You are free to use this material in anyway that is permitted by the copyright and related rights legislation that applies to your use. For other uses

you need to obtain permission from the rights-holder(s) directly, unless additional rights are indicated by a Creative Commons license In the record Are Volatility Expectations in Different Countries Interdependent-

and/ or on the work itself. This material has been accepted for inclusion by faculty at Illinois Wesleyan University'. For more information, please co

Are Volatility Expectations in Different Countries Interdependent-

ntact digitalcommons@iwu.edu.^Copyright is owned by the author of this document.Are Volatility Expectations in Different Countries Interdependent? A D

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-ility indices has increased rapidly. Although the dynamics of realized volatility spillover have been studied extensively, very few studies exist that

examine the spillover between these implied volatility indices By using OAG-based structural vector autoregression, this paper provides evidence that Are Volatility Expectations in Different Countries Interdependent-

implied volatility spillover differs from realized volatility spillover. Through solving the well-known VAR identification problem for these indices,

Are Volatility Expectations in Different Countries Interdependent-

this paper finds that Asia, more specifically Hong Kong, plays a central role in implied volatility spillover during and after the 2008 financial cri

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-italcommons iwu edu/uer/voll4/issl/8de Silva: Are Volatility Expectations in Different Countries Interdepei1. IntroductionSince its creation in 1993.

the CBOLÌ Volatility Index (V1X) has become widely considered as one of the best measures of investor sentiment in the world. Although the calculation Are Volatility Expectations in Different Countries Interdependent-

of the V1X is quite complex, it has become an invaluable source of information because it is a good gauge of fear among investors. When investors ope

Are Volatility Expectations in Different Countries Interdependent-

n a newspaper to the slock market section or open slock market apps on then phones, chances are that they will see the current level of the VĨX report

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-ndices based on equity indices in different countries have been created. Moreover, there has been an explosion of exchange-traded products that track

the VIX, making understanding the dynamics of VTX movements more important to investors.Despite the prevalence of research on volatility spillover (ll Are Volatility Expectations in Different Countries Interdependent-

amao. Masulis. and Ng (1990); Engle (1994); Kanas (1998)), very little work has been done to study the dynamics of the spillover between volatility in

Are Volatility Expectations in Different Countries Interdependent-

dices. The large body of previous literature on volatility' spillover has calculated volatility from returns, using a GARCH-like variance equation or

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-g realized volatility spillover are quite limited because there is no way for investors to gain exposure to realized volatility.1 On the other hand, t

he VIX and other volatility indices that have been subsequently created are based on the implied volatility of the options traded on their respective Are Volatility Expectations in Different Countries Interdependent-

underlying equityindices. The most important component in any option pricing model is investor’s estimate of implied volatility'. Consequently, unlike

Are Volatility Expectations in Different Countries Interdependent-

realized volatility', if an investor has an edge in understanding implied volatility movements, they can monetize this edge through trading options o

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent- world. Given the past literature on realized volatility- spillover, there is strong evidence that implied volatility indices should be interdependent

. Previous literature (ỉỉamao, Masulis. and Ng (1990); Engle (1994); Kanas (1998)) has demonstrated that most of realized volatilityspillover conics f Are Volatility Expectations in Different Countries Interdependent-

rom the US. Given the popularity of the V1X, one would expect that this would be true for implied volatility spillover as well. This paper makes a str

Are Volatility Expectations in Different Countries Interdependent-

ong case for a difference in spillover dynamics between implied and realized1 Aside from buying the replicating portfolio of a variance swap, which is

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent- 14 (20171, Iss. 1. Art. 8volatility that merit further research, namely that the US might not be the largest source of implied volatility transmissio

n.In order to examine the spillover among implied volatility indices in different countries, this paper uses forecast error variance and historical de Are Volatility Expectations in Different Countries Interdependent-

compositions from a directed acyclic graph (DAG)-based structural vector autoregression. This technique has been previously applied by Bessler and Yan

Are Volatility Expectations in Different Countries Interdependent-

g (2003) and Yang and Zhou (2013) to equity indices and credit spreads, respectively. A DAG is a technique that is useful for identifying the contempo

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-toregression (VAR) model. The use of DAG to solve the identification problem in the VAR is significantly more attractive than the widely used Cholesky

factorization2, which makes a strong assumption about the true data generating process and is extremely sensitive to variable ordering.3The contribut Are Volatility Expectations in Different Countries Interdependent-

ion of this paper is fourfold. First, this paper adds to the very small area of literature surrounding spillover among implied volatility indices by e

Are Volatility Expectations in Different Countries Interdependent-

xamining more volatility indices over a longer sample period than has previously been done. To my knowledge, only tlưee papers (Aboura (2003); Narwal.

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-ttempt to solve the identification problem for volatility indices to estimate a structural VAR. while the past literature has simply used a reduced-fo

rm VAR. Most notably, this paper demonstrates that, contrary to past literature and economic intuition, the US is not the largest source of global imp Are Volatility Expectations in Different Countries Interdependent-

lied volatility transmission.Second, this paper contributes to the existing literature surrounding volatility transmission across different markets du

Are Volatility Expectations in Different Countries Interdependent-

ring the 2007 global financial crisis. Although there has been a large amount of studies on the financial crisis, (Duncan and Kabundi (2013); Dungey a

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t

Are Volatility Expectations in Different Countries Interdependent-he change in contemporaneous correlation structure of implied volatility indices. The results of this paper suggest that although the US plays a large

role in spillover during the crisis. Asia plays a significant role at the start of the crisis and is an important factor in explaining the implied vo Are Volatility Expectations in Different Countries Interdependent-

latility2 This factorization assumes that the contemporaneous casual structure between variables in a VAR IS lower triangular.•' See discussion in Bes

Are Volatility Expectations in Different Countries Interdependent-

sler and Yang (2003).

Undergraduate Economic ReviewVolume 14 Issue 1Article 82017Are Volatility Expectations in Different Countries Interdependent? A Data-Driven Solution t