Do markets behave as expected? Empirical test using both implied volatility and futures prices for the Taiwan Stock Market

An-Pin Chen*, H. Y. Chiu, C. C. Sheng, Y. H. Huang

*Corresponding author for this work

Research output: Chapter in Book/Report/Conference proceedingConference contribution

1 Scopus citations

Abstract

This study adopts derivative pricing as an indicator of market expectations, with those results suggesting that general investors can use market expectations to predict the final settlement value of underlying assets. Most investment textbooks note that one of the major functions of futures is price discovery. Similarly, the implied volatility associated with option prices can be used to discover the volatility of the underlying asset. This study combines futures price and implied volatility to establish a probability space of market expectations regarding the final settlement value of the underlying asset, and verifies this probability space using empirical data from the Taiwan stock market. The verification results suggest that market expectations closely reflect the actual behavior of the final settlement value of the underlying asset, and thus provide a practical perspective on future price behavior. According to this study, investors can easily estimate underlying asset behavior based on the behavior of the related futures and options and without incurring significant measurement error, which can be helpful in risk management and planning investment strategies.

Original languageEnglish
Title of host publicationComputational Finance and its Applications II
Pages299-308
Number of pages10
DOIs
StatePublished - 1 Dec 2006
Event2nd International Conference on Computational Finance and its Applications, COMPUTATIONAL FINANCE 2006, CF06 - London, United Kingdom
Duration: 27 Jun 200629 Jun 2006

Publication series

NameWIT Transactions on Modelling and Simulation
Volume43
ISSN (Print)1743-355X

Conference

Conference2nd International Conference on Computational Finance and its Applications, COMPUTATIONAL FINANCE 2006, CF06
CountryUnited Kingdom
CityLondon
Period27/06/0629/06/06

Keywords

  • Forecasting
  • Futures
  • Implied volatility
  • Market expectation
  • Probability space

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    Chen, A-P., Chiu, H. Y., Sheng, C. C., & Huang, Y. H. (2006). Do markets behave as expected? Empirical test using both implied volatility and futures prices for the Taiwan Stock Market. In Computational Finance and its Applications II (pp. 299-308). (WIT Transactions on Modelling and Simulation; Vol. 43). https://doi.org/10.2495/CF060291