【Abstract】

With machine learning tools, we document that firm fundamentals have explanatory power on the shape of the option implied volatility (IV) curve that is both economically and statistically significant. We also find that, after accounting for fundamentals, the associated IV process can generate overreaction in the long-term IV with respect to change in the short-term IV, and can allow a positive profit from at-the-money straddle writing, explaining puzzling patterns in the literature. We also provide a simple model linking the IV to firm fundamentals, which permits realistic IV curves and is consistent with the empirical findings.

【Keywords】

Option implied volatility; Volatility skew; Firm fundamentals; Option puzzle; LASSO

【Authors】

Chen Ding, Department of Accounting and Finance, University of Sussex

Guo Biao, Research Fellow of IMI, School of Finance, Renmin University of China

Zhou Fuguo, Olin School of Business, Washington University in St. Louis