Events

Prof. Viktor Todorov
Harold H. Hines Jr. Professor of Risk Management & Professor of Finance
Kellogg School of Management
Northwestern University

Absence of arbitrage implies that equity and options markets should agree about volatility due to small and frequent moves in the asset price, and in particular about diffusive volatility. We design a formal test for deciding whether violations of this fundamental no-arbitrage condition, that links equity and options markets, exist empirically. The test is nonparametric and uses intraday high-frequency data on a given day for an asset and zero-date options (options that expire within a day) written on it. It utilizes the fact that when equity and options markets are fully integrated, suitable portfolios of zero-date options are the optimal forecasts of future short-term volatility due to small and frequent moves in asset prices. Empirically, we find evidence for episodes of disagreement between equity and options markets. These episodes exhibit mild persistence and are more pronounced for individual stocks than for market indices.