Working Paper: NBER ID: w16764
Authors: Alexander David; Pietro Veronesi
Abstract: Shocks to equity options' ATM implied volatility (ATMIV) are followed by persistently lower short-term rates. Shocks to the ratio of OTM puts' over OTM calls' implied volatilities (P/C) are followed by persistently higher rates. The stock's and Treasury-bond's ATMIV indices, which measure market and policy uncertainty, are counter-cyclical while the P/C index, which measures downside risk, is pro-cyclical. An equilibrium model where investors and the central bank learn about composite regimes on economic and policy variables explains these options' dynamics, linking them to a learning-based, forward-looking Taylor rule. The model produces several predictions on the relation between options, monetary policy variables, and beliefs that find support in the data.
Keywords: Implied Volatility; Monetary Policy; Investor Sentiment; Option Pricing
JEL Codes: G12; G13; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shocks to the ATM implied volatility (ATMIV) of stocks (C58) | future short-term interest rates (E43) |
| shocks to the PC ratio (E39) | future short-term interest rates (E43) |