Intermediary Constraints And Implied Volatility From Bid And Ask Price Of Option

Intermediary asset pricing theories assert that financial intermediary constraints and risk preference would do affect prices of risky assets while traditional asset pricing theories and behavioral finance do not take the impact of intermediaries on asset pricing into consideration.It is well known that market-makers are net sellers of deep out-of-money put options during nomal times.But they no longer want to be due to the management of tail risk exposures during times of market diatress.This paper argues that financial intermediaries do not want to hold net short positions of deep out-of-money put options and they would choose to improve the quotes for a tightening of their constraints.This leads to the differences of implied information included in the ask prices and the bid prices of options and the ask prices contains more information about financial intermediary constraints.According to the theories of financial intermediary asset pricing,the ask prices of option with more information of intermediary constraints should have a good predictability for future earnings of stocks.Therefore,in this paper,BS implied volatility is introduced from the ask price and bid price of the deep out-of-money put options,which could be used to predict the risk premia of stocks.In-sample tests and out-of-sample forecasts show that the implied volatility both from ask price and bid price have good predictabilities to future yield of stocks of which the implied volatility from the ask price does better.In addition,this paper found that stock future return is more sensitive to the implied volatility from option bid price when financial market is good while the ask price implied volatility show higher sensitivity during times of market stress.