Groupe d’études et de recherche en analyse des décisions

The economic value of volatility timing using realized volatility for hedged S&P 500 index options

Hugo Lamarre HEC Montréal, Canada

This paper examines the economic value of volatility timing for an investor who sells and hedges options motivated by positive return expectations. Our empirical focus is on the relative value of hedging protocols applied to out-of-the-money put options sold unconditionally from 2002 to 2014. A held-until-maturity hypothesis allows us to depart from classical delta-hedging towards risk-minimization, which offers a more viable test for ranking market dynamics. In particular, we estimate the incremental value of sourcing information from volatility models based on low- versus high-frequency data. In the latter case, the proposed methodology is a novel non-myopic approach to hedging contingent claims in incomplete markets using realized-variance. We find positive economic value from volatility timing and positive incremental value from relying on high-frequency data. Both conclusions are robust to model specifications and moneyness-maturity pairs. All proposed risk-minimizing hedges under time-varying volatility significantly out-perform model-free delta-hedges.

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