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Published online: 24 May 2014
© Indian Institute of Management Calcutta 2014
Abstract This study investigates the contemporaneous inter-temporal relationship between implied volatility index and stock returns. The empirical evidence reveals that an asymmetry prevails among India VIX and the Nifty index; at the same time, the magnitude of asymmetry is not identical. The results show that the change in India VIX occurs bigger for the negative return shocks than that of positive return shocks. The empirical model described that long-run inter-temporal contemporaneous relation persists between the implied volatility and stock market returns. Moreover, the cross correlation has supported the past literature that current values of change in volatility and stock returns are negatively correlated, and past and current stock returns are positively associated with the future stock market volatility. The magnitude of the change of volatility in response to the return variation, one can use that level of changes as one of the inputs for the pricing of future options.
Keywords Inter-temporal * IVIX * India VIX * Nifty index * Implied volatility
Introduction
The researchers and analysts are keenly interested to analyze the stock market volatility that how it is influenced by large negative returns and the behavior attributed toward positive and near zero-returns. As implied volatility explains the future stock market volatility, hence it is essential to study the contemporaneous relationship between implied volatility index and stock returns. The literature well documents that there is a significant negative correlation between stock returns and implied volatility index. In addition, the nature of impact on the stock returns is asymmetric i.e., the negative return shocks have larger impact on implied volatility than the positive return shocks. Hence, the motivation of the study is to compare the impact of negative and positive return shocks on the expected market volatility.
The option's implied volatility is the forward looking measure of future volatility. It is the volatility to be observed for the life of the options. The Chicago Board of Options Exchange (CBOE) has calculated implied volatility index knows as VIX, underlying S&P 500 option's based volatility index for the near term. The implied volatility indices are considered as the investor's fear-gage index (Whaley 2000); it is the expectation of the investor about the next...