ExperimentalFinanceLecture-5F

ExperimentalFinanceLecture-5F - Experimental Finance IEOR...

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Experimental Finance IEOR – Spring 2012 Mike Lipkin, Pankaj Mody
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Experimental Finance Mike Lipkin, Alexander Stanton Page 2 Lecture 5f Dynamics Consider the following scenarios: Stock XYZ; price, S 0 = 50.00; 3 weeks to go to expiration. Earnings date: 4 weeks away . For concreteness, we take the front month options to be the Junes. Which option generally has the higher implied vol, the Jun 50 C or Jul 50 C? Suppose that XYZ announces a change in the earnings announcement, moving the date ahead 1 week . What will happen to the implied vols? Suppose XYZ preannounces earnings today; what will happen to the vols? Will it matter whether the announcement is better than expected, or worse? Usually, only bad earnings gets preannounced.
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Experimental Finance Mike Lipkin, Alexander Stanton Page 3 Lecture 5f Dynamics Some basics: How many times a year are earnings announced? What would happen if a stock fails to announce earnings? Imagine that earnings are coming out in 2 days (Jun expiry), and XYZ drops $3 to $47.00. What will happen to the Jun 50 vol? Suppose earnings are announced and XYZ drops $3 to $47.00. What will happen to the Jun 50 vol? What is the difference between these two scenarios?
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Experimental Finance Mike Lipkin, Alexander Stanton Page 4 Lecture 5f Dynamics There are two kinds of new information that get disseminated in the marketplace. They are scheduled events and unscheduled ones. It is often pretty easy to distinguish between the two. Let s try some examples: Earnings Drug trial results Upgrades/downgrades by analysts Terrorist bombing in USA or Western Europe Articles in the news media Fed open market meeting/short rate change Mergers/take-overs/acquisitions State/federal actions for improprieties Corporate personnel changes (CEO, CFO, etc.)
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Experimental Finance Mike Lipkin, Alexander Stanton Page 5 Lecture 5f Dynamics One of the things which we should like to understand is how the volatility surfaces adjust themselves before and after both kinds of events. In a thorough research project, one would examine stocks in different industry groups, of different market caps, etc., and look for regularity. Is there an existing theory which addresses these concerns? No. Note: Theory is different than empirical results. Good (predictive) results will never get published! Why???
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Experimental Finance Mike Lipkin, Alexander Stanton Page 6 Lecture 5f Dynamics Earnings announcements come (usually) at very specific, well-defined times. What frequency? For some stocks, earnings are a small effect; which ones might these be? For others, earnings announcements move the stock more than any typical daily move. As a result, the implied volatilities increase strongly heading into earnings. In this way, IVs are anticipative.
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