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Credit-Implied Forward Volatility and Volatility Expectations

Byström, Hans LU (2015) In Working Paper / Department of Economics, School of Economics and Management, Lund University
Abstract
We show how one can back out implied forward volatility term structures from credit default swap spreads. Such forward stock volatility term structures are useful for instance in forward start option pricing. We find the term structure to be downward-sloping, and the credit market's volatility forecasts tend to vary more across time than across maturities. Long-term volatility expectations, in turn, are found to be low and stable while short-term expectations are higher and more volatile. The volatility expectation’s mean-reversion rate, finally, indicates that the credit market expects volatility shocks in the equity market to last for several years.
Please use this url to cite or link to this publication:
author
organization
publishing date
type
Working Paper
publication status
published
subject
keywords
forward start options, forward volatility, implied volatility term structure
in
Working Paper / Department of Economics, School of Economics and Management, Lund University
issue
34
pages
17 pages
publisher
Department of Economics, Lund Universtiy
language
English
LU publication?
yes
id
292d9a3f-fc81-432a-84c9-b169460edf37 (old id 8230911)
alternative location
http://swopec.hhs.se/lunewp/abs/lunewp2015_034.htm
date added to LUP
2015-11-25 16:40:21
date last changed
2016-08-29 16:26:57
@misc{292d9a3f-fc81-432a-84c9-b169460edf37,
  abstract     = {We show how one can back out implied forward volatility term structures from credit default swap spreads. Such forward stock volatility term structures are useful for instance in forward start option pricing. We find the term structure to be downward-sloping, and the credit market's volatility forecasts tend to vary more across time than across maturities. Long-term volatility expectations, in turn, are found to be low and stable while short-term expectations are higher and more volatile. The volatility expectation’s mean-reversion rate, finally, indicates that the credit market expects volatility shocks in the equity market to last for several years.},
  author       = {Byström, Hans},
  keyword      = {forward start options,forward volatility,implied volatility term structure},
  language     = {eng},
  number       = {34},
  pages        = {17},
  publisher    = {ARRAY(0xa425718)},
  series       = {Working Paper / Department of Economics, School of Economics and Management, Lund University},
  title        = {Credit-Implied Forward Volatility and Volatility Expectations},
  year         = {2015},
}