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The relationship between implied volatility and autocorrelation

Robert W. Faff (Department of Accounting and Finance, Monash University, Victoria, Australia)
Michael D. McKenzie (School of Economics and Finance, RMIT University, Melbourne, Australia)

International Journal of Managerial Finance

ISSN: 1743-9132

Article publication date: 10 April 2007

Abstract

Purpose

This paper empirically assesses the determinants of conditional stock index autocorrelation with particular emphasis on the impact of return volatility that are theoretically linked through the behaviour of feedback traders.

Design/methodology/approach

The S&P 100, 500 and the NASDAQ 100 index are considered and volatility in each series is captured using option‐implied estimates taken from the Chicago Board Options Exchange. A seemingly unrelated regression approach is used in which trading volume and volatility are simultaneously modelled.

Findings

The results of this study suggest that low or even negative return autocorrelations are more likely in situations where: return volatility is high; price falls by a large amount; traded stock volumes are high; and the economy is in a recessionary phase.

Research limitations/implications

The results confirm that previous related work showing a link between autocorrelation and volatility is not induced by a mechanical relation.

Practical implications

Usage of endogenously determined volatility measures in this area of the literature is justified.

Originality/value

This study provides a robustness test of the autocorrelation/volatility relation, as well as a further exploration of the utility inherent in option‐implied volatility.

Keywords

Citation

Faff, R.W. and McKenzie, M.D. (2007), "The relationship between implied volatility and autocorrelation", International Journal of Managerial Finance, Vol. 3 No. 2, pp. 191-196. https://doi.org/10.1108/17439130710738736

Publisher

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Emerald Group Publishing Limited

Copyright © 2007, Emerald Group Publishing Limited