Implied Volatility Reaction Relative to Scheduled Economic News Releases: Evidence from the U.S. Index Options Market

Abstract

The fundamental idea of this thesis work is to examine the links between different economic news announcements and the volatility reaction in the option market to that information. For this purpose, the behavior of S&P 500 and Nasdaq-100 index options’ implied volatility is investigated on the announcement days of major U.S. macroeconomic figures and Federal Reserve’s Open Market Committee meetings. Macroeconomic releases included in the study are ISM Manufacturing, Employment Report, Producer Price Index, Retail Sales, Consumer Price Index and Gross Domestic Product. To investigate the market’s reaction relative to important economic news a regression analysis framework is utilized.

The empirical results show that U.S. macroeconomic variables cause a significant drop in the implied volatility on their announcement dates. It is also evidenced that implied volatility, on average, increases on days without important economic news releases, as hypothesized. Moreover, both these findings are in accordance with earlier empirical findings. In addition to examining the importance of economic news in asset valuation, this study investigates the effect of the underlying instrument on the volatility reaction around important news. It is evidenced that the reaction varies across different volatility indices consisting of stocks from different business sectors.

The third objective of this study is to find out whether the behavior of implied volatility differs across stock market conditions, i.e. bull and bear market. It is reported that important economic announcements have varying impact on volatility over different stages of business cycle. Finally, the importance of the quality of the news announcements is examined. The results show that better than expected news cause a statistically significant decrease in the option implied volatility, whereas worse than expected news is followed by higher implied volatility.