FRIC Research Seminar with Ehud Ronn, Texas McCombs

The FRIC Center will host a Research Seminar with Ehud Ronn, Texas McCombs

Title: Using Equity, Index and Commodity Options to Obtain Forward-Looking Measures of Equity and Commodity Betas, and Idiosyncratic Variance

Abstract:

Defining forward-looking betas and forward-looking idiosyncratic variance as perturbations of historical estimates, we use the market prices of equity and index options under a single-factor market model to compute forward-looking term structures of equity betas and idiosyncratic variance.

Using options on oil companies equities, we are able to discern the market's perceptions regarding these oil companies' prospective beta, and hence signaling their future sensitivity to market changes.  In turn, the prospective fraction of idiosyncratic variance relative to total variance provides a forward-looking market measure for onset of crises, when idiosyncratic risk fades relative to systematic, and complementing the information conveyed by VIX and the CBOE's equity implied correlation.

Extending the one-factor model to a two-factor one, consider again the perturbations to historical idiosyncratic variance.  We are able to confirm the forward-looking two-factor idiosyncratic variance is positively correlated with its one-factor analogue.  Together, both of these forward-looking idiosyncratic variances constitute a prospective indicator of a crisis, and the emergence from one, when using VIX and the implied correlation ICJ as benchmarks.

Location: Augustinus Senate Meeting Room (SP D4)