The Impact of Firm Specific News on Implied Volatilities

Posted: 3 Nov 1998

See all articles by Monique W.M. Donders

Monique W.M. Donders

MeesPierson Investment Bank

Ton Vorst

VU University Amsterdam - Department of Finance and Financial Sector Management; Tinbergen Institute

Abstract

We study the implied volatility behavior of European Options Exchange call option prices around scheduled news announcement days of the underlying stock. Implied volatilities significantly increase during the pre-event period and reach a maximum at the eve of the news announcement. After the news release, the implied volatility drops sharply and is at its minimum four days after the news release. From that point on it gradually moves back to its long run level. These results also hold if implied volatilities are corrected for market-wide changes in volatility by subtracting the implied volatility of the EOE-index or the average implied volatility of a group of control stocks. The volatility of the underlying stocks does not change during the pre- and post-event period. Only at the event date itself movements in the price of the underlying stock are significantly larger than expected, given mean and standard deviation of the stock returns in the control period. Hence, volatility of the underlying assets seems to be higher only on event days. We give an option pricing model based on this one-time jump in volatility. The model implicates a pattern of changes in implied volatilities that roughly agrees with the above described pattern. We test two trading strategies that may profit from the movements in implied volatilities and find that the results are statistically insignificant.

JEL Classification: G13

Suggested Citation

Donders, Monique W.M. and Vorst, Ton A.C.F., The Impact of Firm Specific News on Implied Volatilities. Available at SSRN: https://ssrn.com/abstract=6264

Monique W.M. Donders (Contact Author)

MeesPierson Investment Bank

P.O. Box 243
Derivatives Research
1000 AE Amsterdam
Netherlands

Ton A.C.F. Vorst

VU University Amsterdam - Department of Finance and Financial Sector Management ( email )

De Boelelaan 1105
NL-1081HV Amsterdam
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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