A Study Of VOV Co-movement And Its Impact On Delta-hedged Option Returns

Volatility is a measure of the uncertainty of asset returns.It has a significant impact on the option pricing,and volatility itself has uncertainty in the time dimension.If we do not understand and measure the uncertainty accurately,it will cause a high model risk.This article will consider the impact of volatility on asset returns from the perspective of the uncertainty of volatility,which is measured by volatility and volatility,that is VOV.When the uncertainty of volatility increases,it will bring a great impact on the stability of the volatility estimation,which means that the option seller faces a higher model risk,and the risk-averse option sellers will charge higher premiums used as risk compensation.At present,the research on VOV in the field of financial is a perspective that has only emerged in recent years.The studies on the characteristics of VOV are still in the early stages and not perfect.Currently,there is no related literature to study VOV from the perspective of the co-movement.This article chooses a new point to study the impact of VOV on option returns.Based on the phenomenon of co-movement of VOV,we try to explore its factor structure.In addition,this article treats volatility as asset returns,that is,VOV can be regarded as the volatility of the "asset",which is the higherorder rectangular form of volatility.We study the characteristic of VOV from this perspective and decomposes it.into a market component and an idiosyncratic component,and we define the idiosyncratic component as IVOV innovatively.Next,we study whether IVOV still has a common factor,which is defined as CIVOV,and whether it could partly explain the impact of IVOV on delta-hedged option gains.In this paper,through the classic empirical analysis methods in financial measurement such as single-sort portfolio analysis,double-sort portfolio analysis,Fama-Mac Beth regression,and principal component analysis,VOV and its comovement are thoroughly and comprehensively analyzed as following.First of all,through single-sort portfolio analysis and Fama-Mac Beth regression,we prove that VOV has a negative effect on the delta-hedged option gains.And VOV of individual stocks are co-movement in time.The co-movement is still obvious among industries.And after PCA process,we find that VOV does have a significant factor structure.Based on this conclusion,we then decompose VOV into a market component and an idiosyncratic component,and the idiosyncratic component is defined as IVOV.Next,we study the impact of IVOV on delta-hedged option gain.Through singlesort portfolio analysis and Fama-Mac Beth regression analysis,this article finds that IVOV has a negative impact on delta-hedged option gain as well.Moreover,we further prove that the co-movement in IVOV is still existed,and through PCA method,it is proved that it has one or two common factors.Finally,we define the average of IVOV of individual stocks on cross-section as the common factor,defined as CIVOV,and then explore the impact of CIVOV on deltahedged option gains.Through single-sort portfolio analysis,we find that CIVOV has a significant negative impact on delta-hedged option gains.Through double-sort portfolio analysis,we control option’s exposure to the market component of VOV risk,defined as MKT-VOV-beta,and IVOV separately.Then t-test reveals that when the above two variables are controlled separately,option’s exposure to CIVOV shock,that is CIVOV-beta,still has a significant negative impact on the delta-hedged option gains.This shows that CIVOV-beta is a new common factor that is different from MKT-VOVbeta,and that when controlling CIVOV-beta,the level of negative impact of IVOV on delta-hedge option gains has decreased,which indicates that CIVOV-beta can explain some part of the negative impact of IVOV on delta-hedged option gains.This article deeply studies the impact of VOV in option market,interprets the dynamics of volatility in the time dimension from the perspective of volatility uncertainty,and explores the factor structure of VOV Innovatively.This is of great significance for understanding the dynamic changes of volatility and the pricing and hedging of options.From the perspective of VOV,it is better to understand the changes of volatility,and then to define the model risk caused by volatility estimation errors more accurately.