Do news announcements affect volatility spillovers? Evidence from implied volatilities *

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1 o news announcemens affec volailiy spillovers? Evidence from implied volailiies * George J. Jiang a, Eirini Konsaninidi b, and George kiadopoulos c This draf: epember 29, 2010 Paper No: 10/05 bsrac This paper invesigaes he role of scheduled news announcemens in explaining he ransmission of sock marke volailiy, boh across U.. and European markes and wihin European markes. ased on a se of widely followed implied volailiy indices, we show ha implied volailiy spillovers exis beween U.. and European markes and wihin European markes. In addiion, we consruc various even dummies as well as surprise measures for U.. and European macroeconomic news announcemens. Our resuls sugges ha news announcemens explain parially he repored volailiy spillovers and announcemen surprises have a significan effec on he magniude of volailiy spillovers. Neverheless, volailiy linkages remain significan even afer we conrol for he effec of news announcemens. We show ha he resuls hold even over he period of he 2007 sub-prime deb crisis. n addiional check is also performed by applying he ae, Karolyi and ulz (2003) mehodology ha akes ino accoun exreme co-movemens in * We would like o hank ngelos nzoulaos, Gikas Hardouvelis, ndrew Karolyi, Robin Lumsdaine, ngelo Ranaldo, Chrisodoulos efanadis, and paricipans a he 2009 HF Conference (Thessaloniki), 2010 Financial Managemen ssociaion European Conference (Hamburg), 2010 Conference on Research on Economic Theory and Economerics (Tinos) and Exeer usiness chool seminar for useful discussions and commens. ny remaining errors are our responsibiliy alone. a eparmen of Finance, Eller College of Managemen, Universiy of rizona, rizona. b Xfi Cenre for Finance and Invesmen, Universiy of Exeer usiness chool, UK. c eparmen of anking and Financial Managemen, Universiy of Piraeus, Greece, and Financial Opions Research Cenre, Warwick usiness chool, Universiy of Warwick, UK. addresses: (G.J. Jiang), (E. Konsaninidi), (G. kiadopoulos). 1

2 volailiies. The findings of our sudy shed new lighs on cross-marke informaional efficiency and provide new evidence on volailiy conagion. JEL Classificaion: G13, G14, G15 Keywords: Conagion, Economic News nnouncemens, Implied Volailiy, Implied Volailiy Index, Marke Efficiency, Volailiy pillovers. 1 Inroducion The Crash of Ocober 1987 in U.. sock marke and is impac on oher sock markes around he world has moivaed he growh of a vas lieraure ha explores he ransmission of volailiy across sock markes (see Gagnon and Karolyi, 2006, for an exensive review). urprisingly, he role of news announcemens o explain hese volailiy linkages empirically has received relaively lile aenion. This paper ies ogeher he volailiy spillover and news announcemen lieraure by examining (1) how shocks in volailiy are ransmied boh beween U.. and European sock markes and wihin European markes, (2) how news announcemens accoun for he repored volailiy spillovers, i.e. o wha exen volailiy linkages across markes are driven by news announcemens, and (3) wheher news announcemens affec he magniude of volailiy spillovers, i.e. wheher volailiy spillovers are significanly differen on announcemen days as opposed o non-announcemen days. The answer o hese quesions is of paricular imporance o boh academics and praciioners for a leas he following four reasons. Firs, he ransmission of volailiy shocks from one marke o anoher offers direc evidence of how much markes wihin and across regions are inegraed (see e.g., ekaer e al., 2005, and he references herein). econd, undersanding how volailiy shocks ransmi from one marke o anoher is imporan for inernaional porfolio managemen and risk managemen. For insance, in he case where volailiy is ransmied across markes in a sysemaic way around scheduled news announcemens, i may be possible o devise profiable opion rading sraegies (see e.g., onders and Vors, 1996, Ederingon and Lee, 1996). Third, in he case where volailiy spillovers coninue o show up even afer news announcemens abou fundamenals have been aken ino accoun, his poins o he exisence of volailiy conagion. 1 Fourh, as elaboraed below he exisence of 1 There is no a unanimous agreemen in he lieraure on he definiion of conagion (see Karolyi, 2003, and Pericoli and bracia, 2003, for reviews). We define volailiy conagion o be he exisence of volailiy linkages ha are no linked o prevailing economic condiions as hese are refleced by economic news announcemens (see e.g., ae e al., 2003, and ekaer e al., 2005, for an analogous definiion). This definiion allows disinguishing from volailiy 2

3 volailiy spillovers and heir relaionship o news announcemens have imporan implicaions for markes efficiency. To he bes of our knowledge, Connolly and Wang (1998) is he only sudy ha has examined he relaion beween news announcemens and volailiy spillovers. They have explored wheher news announcemens accoun for he repored volailiy spillovers beween U.., U.K., and Japan. They documen ha news releases explain parially volailiy spillovers; heir impac on he magniude of volailiy spillovers is no examined hough. In addiion, heir sudy is based on realized volailiy where he volailiy measure is consruced from hisorical daa (condiional volailiy model). Insead, we examine he impac of news announcemens on volailiy spillovers by considering implied volailiy in a more general seing han hey do. Implied volailiy is, by definiion, a measure of expeced sock marke volailiy. Hence, i is inherenly a forward-looking measure of marke volailiy and herefore expeced o incorporae informaion on fuure volailiy as opposed o hisorical measures of volailiy (see e.g., Granger and Poon, 2003, for a review of he lieraure on he informaion conen of implied volailiy). In paricular, o address our hree main quesions, we adop major inernaional implied volailiy indices widely followed by academics and praciioners in our sudy. More specifically, we use six European and hree U.. implied volailiy indices ha are consruced in a model-free way and enable capuring he volailiy of he respecive sock markes (see Jiang and Tian, 2005, Carr and Wu, 2006 and he COE VIX whie paper). 2 The value of an implied volailiy index represens he implied volailiy of a synheic opion ha has consan ime-o-mauriy a every poin in ime. In addiion, hey are more informaive han he implied volailiy of a single opion conrac, since hey ake ino accoun he informaion conained in opion prices across he whole specrum of srike prices. Furhermore, using implied volailiy indices is advanageous because hey are no subjec o he considerable measuremen errors ha implied volailiies are noorious for since hey use informaion from ou-of-he money opions (see Henschel, 2003). In addiion, he use of U.. and European implied volailiy indices will also allow us deecing he imporance of he wo regions in explaining implied volailiy spillovers, i.e. wheher here is a European (U..) regional effec where Eurozone (U..) volailiy drives European and U.. volailiy indices. number of sudies have already documened he ransmission of implied volailiy across spillovers ha are due o normal inerdependence across various economies (see also ornbusch e al., 2000, Forbes and Rigobbon, 2002). 2 The COE whie paper can be rerieved from hp:// 3

4 inernaional markes (see e.g., Gemmill and Kamiyama, 2000, kiadopoulos, 2004, Wagner and zimayer, 2004, Nikkinen e al., 2006, Konsaninidi e al., 2008). Moreover, from a heoreical poin of view, news releases are expeced o affec volailiy since hey affec expecaions abou fuure cash flows (see chwer, 1989, for a similar raionale on he relaionship beween volailiy and macroeconomic variables); Ross (1989) showed ha in he absence of arbirage, he insananeous variance of reurns equals he variance of informaion flow. In addiion, he empirical evidence has shown ha implied volailiy drops as soon as a scheduled news announcemen is released (see e.g., Paell and Wolfson, 1979, onders and Vors, 1996, Ederingon and Lee, 1996, Fornari and Mele, 2001, Kim and Kim, 2003, Fornari, 2004, for an examinaion of a-he-money implied volailiy, ailie, 1988, for a sudy of an average of implied volailiies, and eeley, 2004, eber and rand, 2006, Äijö, 2008, for an examinaion of he second momen of opion implied risk-neural disribuions). 3 This finding is consisen wih he models of implied volailiy behavior around scheduled news announcemens suggesed by Paell and Wolfson (1979), and Ederingon and Lee (1996) ha predic ha implied volailiy falls on scheduled news announcemen days. 4 similar reacion o scheduled news announcemens has also been documened in an implied volailiy index seing (see e.g., Chen and Clemens, 2007). However, none of hese sudies has invesigaed he effec of news announcemens o he repored volailiy spillovers; heir analysis is consrained in a single-counry seing. In conras o he previous lieraure, we invesigae he impac of news announcemens on implied volailiy spillovers; a broad se of European and U.. implied volailiy indices and scheduled macroeconomic news releases is employed. The robusness of he resuls over he sub-prime deb crisis period is also examined. To his end, an addiional check is also performed by applying he mehod proposed by ae e al. (2003) ha akes ino accoun exreme 3 In he case of scheduled news announcemens, he iming bu no he conen of he release is known a priori by marke paricipans. There is also some lieraure ha considers unscheduled news announcemens (i.e. neiher he iming nor he conen are known a priori by marke paricipans); implied volailiy is found o increase on unscheduled announcemen days (see e.g., Ederingon and Lee, 1996, Fornari and Mele, 2001). 4 oh models predic ha implied volailiy increases gradually prior o a news release and falls on he announcemen. This predicion is based on he inerpreaion of implied volailiy as he average volailiy expeced unil he expiraion of he opion (see Hull and Whie, 1987), a se of furher assumpions and a shrinking ime o mauriy. Thus, his predicion does no hold for implied volailiy indices ha have a consan ime o mauriy a every poin in ime. However, boh models can be exended so as o accommodae a consan ime o mauriy, ye unambiguous expecaions canno be made wihou making any addiional resricive assumpions. Noe also ha in he case of condiional volailiy, he reverse behavior is anicipaed, namely condiional volailiy is expeced o be low before an imporan release occurs and hen increase on he announcemen (see Cenesizoglu, 2009, for a heoreical explanaion). This is in line wih he empirical evidence repored on he condiional volailiy in bond markes, ermed he calmbefore-he-sorm effec by Jones e al. (1998). 4

5 co-movemens in volailiies. To he bes of our knowledge, his approach is novel and makes a leas six conribuions o he exising lieraure. Firs, i provides evidence wheher volailiy spillovers exis even afer he effec of economic fundamenals refleced by news announcemens has been aken ino accoun. In he case hey do, i begs poenial alernaive explanaions for volailiy spillovers, e.g. he conagion explanaion offered by he model of King and Wadhwani (1990) where raional agens ry o infer informaion from price changes in oher markes hereby causing an increase in volailiy in heir marke. econd, he resul also provides evidence for wheher macroeconomic news releases affec he magniude of implied volailiy spillovers. Third, we examine wheher here is a regional European or U.. effec ha drives changes in volailiy in each region. This is analogous o he lieraure ha aribues a counry s volailiy o hree separae sources, namely he local (i.e. own-counry), he regional (i.e. own-region) and he world (usually he U.. is used as a proxy of he world) componen (see e.g., aele, 2005, ekaer e al., 2005, sgharian and Nossman, 2010). This lieraure has found mixed resuls, in he sense ha he regional componen is more imporan in some cases (see e.g., ekaer e al., 2005, sgharian and Nossman, 2010) and he U.. componen dominaes in some oher (see e.g., aele, 2005). Fourh, we examine he impac of boh U.. and European news releases; he lieraure on he effec of news announcemens on implied volailiy has considered ha of eiher U.. or European releases separaely. 5 In addiion, he use of various U.. and European release iems enables us o deec heir respecive individual as well as aggregae impac on he dynamics of implied volailiy indices. Previous sudies have primarily focused on examining he effec of individual news release on volailiy, wih he excepion of Nofsinger and Prucyk (2003) and de Goeij and Marquering (2006) who employed aggregae news announcemens wihin a single-counry seing. Fifh, we invesigae he announcemen and surprise effec of news releases wihin a volailiy spillover framework. 6 Examining hese wo ypes of effec has ineresing implicaions regarding marke efficiency. This is because he marke efficiency hypohesis (see e.g., Fama, 1970, renner 5 Nikkinen and ahlsröm (2004) and Äijö (2008)considered he effec of boh European and U.. releases on implied volailiy. The former sudy has found ha only he U.. news announcemens exer a significan impac on implied volailiy, while he laer documens ha boh he European and he U.. announcemens affec implied volailiy. 6 In he case of he announcemen effec, only he iming of he releases is considered and news announcemens are modeled merely as evens. In he case of he surprise effec, he iming as well as he conen of he releases is aken ino accoun and news announcemens are measured by heir unexpeced componen (i.e. surprise elemen). similar erminology has been used in he lieraure. More specifically, eber and rand (2006) use he erms uncondiional and condiional response for he announcemen and he surprise effec, respecively, and Chrisiansen and Ranaldo (2007) use he erms announcemen and news effec. 5

6 e al., 2009) dicaes ha financial markes should reac only o he unexpeced componen of news announcemens. Hence, evidence of a surprise effec would be consisen wih his heory. On he oher hand, evidence for an announcemen effec bu no a surprise one would no suppor he noion of marke efficiency. ixh, he curren sudy adds o he lieraure on he predicabiliy of implied volailiy (see e.g., Konsaninidi e al., 2008, and he references herein). This is because undersanding he way implied volailiy is ransmied across markes and he role of news announcemens may help consrucing poenially superior implied volailiy forecass. The res of he paper is srucured as follows. The following secion describes he daase. In ecion 3, he research mehodology and he resuls perinen o implied volailiy spillovers are presened. ecion 4 explores he exen o which implied volailiy spillovers are preserved once he announcemen and surprise effec of aggregae regional and individual news announcemens has been aken ino accoun. ecion 5 examines he impac of aggregae and regional news announcemens on he magniude of implied volailiy spillovers. ecion 6 invesigaes he robusness of he resuls repored in he previous secions in he case where he period over he recen sub-prime crisis is considered. The final secion concludes and discusses he implicaions of he findings. 2 aa The daa consis of daily closing levels of nine implied volailiy indices and a se of macroeconomic news announcemens obained from loomberg. The sample spans he period from February 2, 2001 o January 8, 2010, so as o sudy all indices over a common ime period. Three U.. (VIX, VXN and VX) and six European (VX-NEW, VCC VEX, VEL, VMI and VTOXX) implied volailiy indices are considered. ome of he previous sudies have examined he reacion of financial marke volailiy o news announcemens by using inra-day daa (see e.g., Chen e al., 1999, for an examinaion of sock marke volailiy). We focus insead on he daily closing prices of he implied volailiy indices under consideraion. The choice of daily daa is no casual. Firs, high-frequency daa are unavailable for mos implied volailiy indices under consideraion. econd, closing prices are less noisy han he inra-day ones ha suffer from microsrucure fricions (see renner e al., 2009, for a discussion and he references herein). Furhermore, closing prices are immune o he leakages of he announcemen informaion prior o he acual release (see irru and Figlewski, 2010) and he adjusmen of volailiy o is 6

7 equilibrium level afer he occurrence of he announcemen (see Ehrmann and Frazscher, 2005, and irru and Figlewski, 2010). Third, we make sure ha he subsequen resuls will no be subjec o he non-syncronous closing prices across markes. We noe ha he U.. sock index opion markes close a 4:15pm Easern Time (ET) and he European sock index opion markes close a 11:30 am ET (see Figure 1). In our analysis, we recognize he ime differences and only include news announcemens occurred before he close ime of each marke; we commen furher on his in he las par of his secion. The consrucion algorihm of all implied volailiy indices is based on he concep of model-free implied variance proposed by rien-jones and Neuberger (2000). 7 The indices represen he 30-day variance swap rae once hey are squared (see Carr and Wu, 2006, and he references herein). 8 VIX, VXN, and VX are exraced from he marke prices of opions on he &P 500, Nasdaq 100, and ow Jones Indusrial verage (JI) index, respecively. VX- New, VCC, VEX, VEL, VMI and VTOXX are consruced from he marke prices of opions on he X (Germany), he CC 40 (France), he EX (Neherlands), he EL 20 (elgium), he MI (wizerland) and he J RO TOXX 50 index, respecively. The daa for all he implied volailiy indices are obained from loomberg. Table 1 shows he summary saisics of he implied volailiy indices (in levels and firs differences, Panels and, respecively). The firs order auocorrelaion ρ 1, he Jarque-era and he ugmened ickey Fuller (F) es values are also repored. We can see ha none of he implied volailiy indices is normally disribued eiher in levels or in firs differences. In addiion, mos indices exhibi srong auocorrelaion in he levels and in he firs differences. Finally, he values of he F es show ha implied volailiy indices are non-saionary in he levels, and saionary in he firs differences (see also osis e al., 2007, for a sudy on he dynamics of various implied volailiy indices). Twelve U.. and eigh European scheduled news announcemen iems are also employed in our sudy. The exac iming of he releases and heir corresponding survey forecass are obained 7 The consrucion algorihm of all implied volailiy indices is based on he concep of he fair value of he variance swap rae suggesed by emeerfi e al. (1999). Jiang and Tian (2007) have shown ha his concep is equivalen o he model-free implied variance. 8 variance swap is a forward conrac on annualized variance; he buyer (seller) of he conrac receives he difference beween he realized variance of he reurns of a saed index and a fixed variance rae, ermed variance swap rae, if he difference is posiive (negaive). 7

8 from loomberg. 9 Every Friday, loomberg surveys key financial insiuions for heir forecass regarding he values of economic variables ha will be released wihin he nex week. The median of he responses is considered as he survey forecased value for he respecive economic variable (see Vähämaa e al., 2005). The U.. economic variables under consideraion are he change in non-farm payrolls (NFP), he consumer confidence index (CCI), he consumer price index (CPI), he durable goods orders (GO), he FOMC rae decision (FOMC), he gross domesic produc (GP), he iniial jobless claims (IJC), he IM non-manufacuring (IM), he leading indicaors (LI), he new home sales (NH), he producer price index (PPI), and he reail sales less auos (R). The European news announcemens include he EC ineres rae (EC), he Euro-zone consumer confidence index (-CCI), he Euro-zone consumer price index (-CPI), he Eurozone gross domesic produc (-GP), he Euro-zone producer price index (-PPI), he Eurozone reail sales (-R), he IFO business climae (IFO), and he ZEW survey (ZEW). The various news announcemen iems are briefly defined in Table 2. Table 3 repors he source, iming, frequency, unis of measuremen and oal number (N) of he news announcemens in our sample. We can see ha mos news announcemen iems are repored on a monhly basis. The only excepions are he iniial jobless claims announcemen ha is released every week, and he FOMC rae decision and he EC ineres rae announcemens (eigh and eleven imes per annum, respecively). In addiion, all bu one releases included in our sample occur before he U.. opion markes close on day (i.e. before 4:15pm ET). 10 Furhermore, mos of he announcemens occur before he European opion markes close (i.e. before 11:30am ET). ll bu one releases ha occur afer he closing of he European opion markes on day refer o he FOMC rae decision. Noe ha in he case where an announcemen occurs on day before he markes close, his release will have an impac on he changes of he implied volailiy indices beween -1 and. On he oher hand, if an announcemen occurs on day afer he markes close, hen his release will have an impac on he changes of he implied 9 In general, he loomberg survey forecass have been found o be raional (see wizer and Noel, 2001). imilar findings have also been documened for he Money Marke ervices Inernaional (MM) survey forecass (see e.g., Cambell and harpe, 2009). MM survey forecass have been used frequenly in previous sudies (see e.g., eber and rand, 2006). However, we use he loomberg forecass for wo reasons. Firs, MM forecass are no available for Euro-zone news announcemens. In addiion, i is no clear wheher he mehodology of heir consrucion has changed since This is because, MM was acquired by Informa Group plc in 2003 and does no provide survey forecass any longer. Insead, he survey forecass for he U.. news announcemens are provided by cion Economics llc (see also renner e al., 2009, for a discussion along hese lines). 10 The only excepion is one ou of he 466 iniial jobless claims announcemens ha occurs a 10:30pm ET. 8

9 volailiy indices beween and +1. This will be aken ino accoun o measure he relaed variables ha will be employed in he specificaions described in ecion 3. 3 Implied volailiy spillovers We begin our analysis by invesigaing wheher implied volailiy is ransmied across markes. o, hypohesis H1a is formulaed: H1a: Implied volailiy spillovers do no exis beween counries. To es H1a we esimae a sandard VR(1) model, i.e. ΔIV C ΦΔIV ε (1) 1 where ΔIV IV IV 1 is he (9x1) vecor of changes in he implied volailiy indices beween -1 and, C is a (9x1) vecor of consans, Φ is a (9x9) marix of coefficiens, and ε is a (9x1) vecor of residuals. The number of lags has been chosen so as o minimize he IC crierion and keep he model parsimonious. Previous sudies have also employed a VR modeling framework o invesigae he presence of implied volailiy spillovers (see e.g., Gemmill and Kamiyama, 2000, kiadopoulos, 2004, Nikkinen e al., 2006, Konsaninidi e al., 2008). Table 4 shows he esimaed coefficiens, -saisics and adjused R 2 for he VR(1) model. One and wo aserisks denoe rejecion of he null hypohesis of a zero coefficien a he 1% and 5% level, respecively. We can see ha he coefficiens of he auoregressive erms are found o be joinly significan and hence H1a is rejeced. This implies ha implied volailiy is ransmied beween and wihin regions. In paricular, implied volailiy is ransmied from U.. o Europe, since he lagged changes in VIX and VXN have a significan impac on mos European volailiy indices. In addiion, all U.. volailiy indices are significanly affeced by he lagged changes in VX, VCC and VMI. Thus, implied volailiy also spills over from Europe o he. Furhermore, here are some effecs wihin regions, as lagged changes in VTOXX are significan for all European indices apar from VEX. Moreover, we can see ha he lagged implied volailiy index ha serves as he dependen variable is significan in mos cases, suggesing ha implied volailiy index changes are auocorrelaed. Finally, he adjused R 2 is generally greaer for he European implied volailiy indices han for he U.. ones and akes he larges value for he VMI (22%) and he lowes for he VXN (3.7%). These findings are in line wih Melvin and 9

10 Melvin (2003) who documen he presence of meeor showers (i.e. volailiy spillovers across markes) and hea waves (i.e. auocorrelaion in volailiy), while hey are also parially consisen wih Engle e al. (1990) who find meeor showers in foreign exchange markes. Nex, we invesigae wheher here is a European (U..) regional effec, i.e. wheher Eurozone (U..) volailiy drives European and U.. volailiy indices. appropriaely modified: H1b: There is no U.. and/or European effec. To his end, H1a is To examine he significance of he U.. and he European effec, a univariae regression seing is employed. More specifically, in he case of he U.. implied volailiy indices H1b is esed by esimaing he following specificaion: IV c IV PC i, i i i, 1 i i, 1 i, where ΔIV i, IV i, IV i, 1 is he change in he i-h implied volailiy index beween -1 and (i = 1 for VIX, 2 for VXN, 3 for VX) and PC i, 1 is he lagged firs principal componen exraced from applying principal componen analysis (PC) o he se of all European implied volailiy indices. The employed PC akes ino accoun he presence of any spillover effecs from Europe o he U.. and capures he European effec, while he lagged implied volailiy index capures he U.. effec. Hence, he null hypohesis o be esed is H1b: φ a 0 for i = 1, 2, 3. In he case of he European implied volailiy indices, we esimae he following specificaion: i, i i i, 1 i i, 1 i i, 1 i, i i IV c IV PC PC (3) where i = 4 (for VX), 5 (for VCC), 6 (for VEX), 7 (for VEL), 8 (for VMI), 9 (for r VTOXX) and PC i, 1 is he lagged firs principal componen exraced from applying PC o he se of implied volailiy indices of region r (r = 1 for he U.. and r = 2 for European indices) where he i-h implied volailiy index is excluded from his se. The PC i, 1 ( PC i, 1) akes ino accoun he presence of spillovers from U.. (from he remaining European implied volailiy indices) o he i-h European implied volailiy index and capures he U.. effec (European effec). 11 This implies ha he null hypohesis o be esed is H1b: a a 0 for i = 4, 5,,9. i i (2) 11 Noe ha in equaion (2) he regressor PC i, 1 (i.e. he lagged firs principal componen exraced from applying PC o he U.. indices by excluding he i-h implied volailiy index) has no been included. This is because VIX, VXN, 10

11 Table 5 shows he esimaed coefficiens, -saisics in parenheses and he adjused R 2 for equaions (2) and (3). In he case of he U.. implied volailiy indices, we can see ha neiher he lagged indices nor he PC i, 1 are significan. This suggess ha here is no U./European effec for he U.. indices and hence, H1b canno be rejeced in his case. On he oher hand, H1b is rejeced for each one of he European implied volailiy indices. This is because he PC i, 1 affecs sysemaically all European indices, which implies ha here is a U.. effec in his case. This asymmeric implied spillover effec is in line wih he findings of Hamao e al. (1989) who documen ha he U.. condiional volailiy is ransmied o oher markes bu he reverse does no hold. 4 The effec of news announcemens on implied volailiy spillovers 4.1 The announcemen and surprise effec of news releases: efiniions We invesigae wheher implied volailiy spillovers persis even once he effec of news announcemens on he dynamics of implied volailiy is aken ino accoun. To his end, a VR(1) model ha allows for he vecor of consans o be affeced by news releases is employed. In paricular, he announcemen and surprise effecs of aggregae, regional and individual releases on implied volailiy dynamics are considered. The announcemen effec accouns only for he iming of he releases. In his case, news announcemens are modeled merely as evens, i.e. dummy variable(s) are employed o capure he arrival of informaion. The surprise effec akes ino accoun he iming as well as he conen of he releases. In his case, news announcemens are measured by heir unexpeced componen (i.e. surprises). More specifically, we use he absolue value of he sandardized surprise elemen, i,, of a release of iem i a ime ha has been commonly used in he lieraure (see e.g., alduzzi e al., 2001, renner e al., 2009, Jiang e al., 2010, and he references herein). This is defined as follows: i, i, i, σ i F (4) where i, F i, is he loomberg released (forecased) value for he i-h economic variable and VX refer o he U.. Thus, including PC i, 1 would capure he own-counry effec (i.e. he U.. effec) which has already been aken ino accoun by including IV i, 1 in equaion (2). 11

12 beween -1 and, and σ i is he sandard deviaion of he unexpeced componen (i.e. i, F i, ) of he announcemens for he i-h economic variable for he whole sample period. sandardizaion helps comparing he effec of differen announcemens ha differ in he unis of measuremen. In addiion, i does no affec eiher he saisiacal significance of he esimaed coefficiens nor he goodness of fi of he specificaion under consideraion (see e.g., alduzzi e al., 2001, renner e al., 2009). Considering he absolue value of i,, assumes implicily ha only he magniude and no he sign of he surprise maers. 12 The This is in line wih Chrisiansen and Ranaldo (2007) who argue ha large posiive and negaive surprises should affec volailiy idenically, since a larger surprise implies greaer uncerainy. Furhermore, aking he absolue value of equaion (4) accommodaes he consrucion of an aggregae surprise measure of all news announcemens under consideraion. This is because our sample includes differen announcemen ypes (e.g., real economic aciviy releases, inflaionary releases ec.) and hence, one canno aggregae heir unexpeced componen wihou aking is absolue value. The consrucion of an aggregae surprise measure is also faciliaed by he fac ha he unexpeced componen of news announcemens has been sandardized [see equaion (4)]. This is because he sandardizaion of he surprise elemen eliminaes he unis of measuremen and hence, allows aggregaing he unexpeced componen across news announcemen iems. Thus, he aggregae absolue surprise componen, U.. and European news announcemen ha occurs beween -1 and is defined as:, of all (5) where 12 8 i, j, i 1 j 1 is he aggregae U.. (European) absolue surprise componen of he announcemens for all of he U.. (European) economic variables ha occur beween -1 and. 4.2 ggregae news releases: nnouncemen and surprise effecs Nex, he effec of aggregae releases on implied volailiy spillovers is explored. ggregae 12 eber and rand (2009) have considered posiive and negaive surprises separaely and inerpre hese as bad and good news, respecively. This inerpreaion is valid since hey consider only inflaionary announcemens wihin a single counry seing. However, such an exercise is no possible in our case since differen news announcemen ypes are considered. 12

13 releases have been used in he pas o examine he impac of news announcemens on volailiy only wihin a single-counry seing (see Nofsinger and Prucyk, 2003, and de Goeij and Marquering, 2006). In a muli-counry seing, lbuquerque and Vega (2009) have considered he effec of aggregae surprises on reurn co-movemens raher han volailiy hough. The following hypohesis is formulaed: H2a: Implied volailiy spillovers do no exis once we accoun for he announcemen effec of aggregae releases. This hypohesis is esed by esimaing a VR(1) model ha allows for he vecor of consans o be affeced by aggregae releases: ΔIV C ΦΔIV ε (6) 1 where ΔIV IV IV ΔIV, ΔIV, 6 1 is a (9x1) vecor wih ΔIV ΔIV being he (3x1) [(6x1)] vecor of changes in he hree U.. (six European) implied volailiy indices beween -1 and, C is a (9x1) vecor of consans, Φ and 1, 3 1 2, 6 1 are marices of coefficiens [(9x9) and (9x1), respecively], * ** is a (2x1) binary vecor wih 13 being a dummy variable * ** ha akes he value 1 when he announcemen for any economic variable occurs beween 4:15pm ET (11:30am ET) on day -1 and 4:15pm ET (11:30am ET) on day and 0 oherwise, * 1 ** 2 is a Khari-Rao produc and ε is a (9x1) vecor of residuals. Equaion (6) can be viewed as an encompassing regression. In he case where he marix urns ou o be saisically insignifican his would favor a volailiy conagion sory (see e.g., King and Wadhwani, 1990). On he oher hand, if he marix Φ urns ou o be saisically insignifican, hen news announcemens are he sole drivers of volailiy changes since hey subsume all informaion available in volailiy spillovers. Finally, i may well be he case ha boh Φ and Α urn ou o be saisically significan where in his case news announcemens would accoun only for a par of he documened volailiy spillovers. The consrucion of he aggregae dummy variable is coningen on wheher he dependen variable in specificaion (6) is a U.. or a

14 European volailiy index. For example, consider a day where only one announcemen iem is released, e.g., he FOMC rae decision is announced a 2:15pm ET (see Figure 1). This release migh have an impac on IV i, for i = 1, 2, 3 (i.e. for he U.. implied volailiy indices) and IV i, 1 for i = 4, 5, 6, 7, 8, 9 (i.e. for he European implied volailiy indices). This is because he U.. opion markes close a 4:15pm ET and he European ones close a 11:30pm ET. Hence, he aggregae dummy variable for he U.. implied volailiy indices akes he value 1 a ime, while for he European ones akes he value 1 a ime +1. Therefore, specificaion (6) is esimaed by using he seemingly unrelaed regression (UR) raher han he ordinary leas squares (OL) mehodology. This is because he individual equaions in (6) do no have idenical explanaory variables and hence, here is an efficiency gain by employing UR insead of OL (see Zellner, 1962). o far, he conen of he news announcemens has been ignored and releases have been considered merely as evens. We urn now o consider he conen of he news announcemen iems. To his end, we employ he aggregae absolue surprise componen of news announcemens [equaion (5)]. Hence, he following hypohesis is formulaed o examine he aggregae surprise effec: H2b: Implied volailiy spillovers do no exis once we accoun for he surprise effec of aggregae releases. H2b is esed by augmening a VR(1) model wih he aggregae surprise variable: ΔIV C ΦΔIV ε (7) 1 where ΔIV IV IV ΔIV, ΔIV, 6 1 is a (9x1) vecor wih ΔIV ΔIV being he (3x1) [(6x1)] vecor of changes in he U.. (European) implied volailiy indices beween -1 and, C is a (9x1) vecor of consans, Φ and 1, 3 1 2, 6 1 are marices of coefficiens [(9x9) and (9x1), respecively], * ** is a (2x1) vecor wih being he aggregae surprise componen 14 * ** of he announcemens for any economic variable ha occur beween 4:15pm ET (11:30am ET) on

15 day -1 and 4:15pm ET (11:30am ET) on day, is a (9x1) vecor of residuals. 1 2 * ** is a Khari-Rao produc and ε Tables 6 and 7 show he resuls for he VR(1) model ha allows for he vecor of consans o be affeced by he aggregae dummy [H2a, equaion (6)] and he aggregae surprise variable [H2b, equaion (7)], respecively. The esimaed coefficiens, he -saisics and he adjused R 2 are repored. In Table 6 we can see ha here is evidence of meeor showers and hea waves even afer he effec of news announcemens is aken ino accoun; his is analogous o he resuls of Melvin and Melvin (2003). More specifically, implied volailiy spillovers remain significan despie he fac ha we have aken ino accoun economic fundamenals as measured by he release of news announcemens. This implies he presence of volailiy conagion across counries. On he oher aside, we can see ha aggregae releases have an announcemen effec on implied volailiy dynamics. In Table 6 we can also see ha he coefficiens of he aggregae dummy variable are negaive in all cases and hence, news announcemens reduce implied volailiy. This is consisen wih he findings of he lieraure on he effec of news announcemens on implied volailiy (see e.g., Paell and Wolfson, 1979, onders and Vors, 1996, Ederingon and Lee, 1996, Fornari and Mele, 2001, Kim and Kim, 2003, Fornari, 2004, eeley, 2004, eber and rand, 2006, Äijö, 2008) and implied volailiy indices wihin a single-counry seing (see e.g., Chen and Clemens, 2007). Ineresingly, i is in conras wih he findings on he reacion of volailiy measures oher han implied volailiy o news releases (see e.g., Jones e al., 1998, who documen ha he condiional volailiy in bond markes increases on he announcemen day). imilar resuls are found when he surprise effec of aggregae releases is aken ino accoun. More specifically, in Table 7 we can see ha volailiy conagion exiss. This is because implied volailiy spillovers coninue o show up despie he fac ha we conrol for he surprise effec of aggregae releases. In addiion, he aggregae surprise elemen of news announcemens has a negaive effec on implied volailiy changes. This is in line wih he findings of Fornari (2004) and suggess ha larger news announcemen surprises resul in a higher reducion in implied volailiy. 4.3 Regional news releases: nnouncemen and surprise effecs Nex, we make a disincion beween U.. and European news announcemen iems. In paricular, 15

16 we examine wheher implied volailiy spillovers remain significan afer he effec of regional aggregae announcemens are aken ino accoun. Previous sudies ha invesigaed he impac of boh European and U.. releases on he implied volailiy of a specific counry have found mixed resuls (see e.g., Nikkinen and ahlsröm, 2004, and Äijö, 2008). Thus, he following hypohesis is formulaed: H3a: Implied volailiy spillovers do no exis once we accoun for he announcemen effec of he U.. and European releases. H3a is esed by considering he aggregae dummy variables for he U.. and European news announcemens separaely in a VR framework. More specifically, a VR(1) model ha allows for he vecor of consans o be affeced by regional aggregae dummy variables, is esimaed by using he UR mehodology: ΔIV C ΦΔIV ε (8) 1 where 1, 3 1 2, 6 1 and 1, 3 1 2, 6 1 are (9x1) marices of coefficiens, r,* r r,** is a (2x1) binary vecor for he news announcemens of region r (r = 1, 2 for U.. and Europe, respecively) wih being a dummy variable ha akes he value 1 when he announcemen for any r,* r,** economic variable of region r occurs beween 4:15pm ET (11:30am ET) on day -1 and 4:15pm ET (11:30am ET) on day and 0 oherwise, ,*,** and Khari-Rao producs and ε is a (9x1) vecor of residuals. We also examine wheher implied volailiy spillovers sill exis once he conen of regional news announcemens are aken ino accoun. Thus, he following hypohesis is formulaed: H3b: Implied volailiy spillovers do no exis once we accoun for he surprise effec of he U.. and European releases. H3b is esed by considering a VR(1) model ha allows for he vecor of consans o be affeced by regional aggregae surprise variables: 1 1 1,*,** ΔIV C ΦΔIV ε (9) are

17 where 1, 3 1 2, 6 1 and 1, 3 1 2, 6 1 are (9x1) marices of coefficiens, r,* r r,** is a (2x1) is a (2x1) vecor wih being he aggregae surprise componen of he announcemens r,* r,** for any economic variables of region r (r = 1, 2 for U.. and Europe, respecively) ha occur beween 4:15pm ET (11:30am ET) on day -1 and 4:15pm ET (11:30am ET) on day, 1 1,*,** and 1 1,*,** are Khari-Rao producs and ε is a (9x1) vecor of residuals. Equaion (9) is esimaed by using he UR mehodology. Tables 8 and 9 show he resuls for he VR(1) model ha allows for he vecor of consans o be affeced by he regional dummy [H3a, equaion (8)] and he regional surprise variables [H3b, equaion (9)], respecively. In he case ha he regional announcemen effec is aken ino accoun, we can see in Table 8 ha H3a is rejeced, i.e. implied volailiy spillovers coninue driving he dynamics of implied volailiies. In addiion, only he regional U.. news announcemens are found o exer a significan impac on mos implied volailiy indices. This implies ha he sysemaic announcemen effec ha was found for he aggregae releases (Table 6) sems from he U.. news announcemens. This is in line wih he findings of Nikkinen and ahsröm (2004) who found ha only he U.. news announcemens affec implied volailiy wihin a single-counry seing. In he case ha he regional surprise effec of news announcemens is aken ino accoun, we can see in Table 9 ha H3b is rejeced. This suggess ha volailiy conagion effecs exis. Furhermore, he U.. (European) surprise elemen is significan for mos U.. and European (only he European) implied volailiy indices. The fac ha he European releases are found o be significan only in he case where hey are modeled as surprises and no as evens, is in accordance wih he marke efficiency hypohesis. I implies ha he conen of he European news announcemens needs o be aken ino accoun for he purposes of explaining he dynamics of implied volailiy. 4.4 Individual news releases: nnouncemen and surprise effecs o far, we have invesigaed wheher implied volailiy spillovers drive he dynamics of implied volailiies afer aking ino accoun he announcemen and surprise effec of aggregae releases, as well as ha of he regional ones. Nex, we urn our aenion o he effec of individual news 17

18 announcemens on he presence of implied volailiy spillovers as a driver of volailiy dynamics. In he case ha he announcemen effec of individual releases is considered, he following hypohesis is esed: H4a: Implied volailiy spillovers do no exis once we accoun for he announcemen effec of he individual releases. To es his hypohesis, he impac of scheduled news announcemens on he nine implied volailiy indices is incorporaed in he VR model and he following specificaion is esimaed by using he UR mehodology: ΔIV C ΦΔIV ε (10) 1 where 1, , 6 12 and 1, 3 8 2, 6 8 are marices of coefficiens [(9x12) and (9x8), respecively],,*,** is a (9x12) binary marix for he welve individual U.. news announcemens wih being a (3x12) [(6x12)] binary marix he (i,j)-h elemen of,*,** which is a dummy variable ha akes he value 1 when an announcemen for he j-h individual U.. economic variable occurs beween 4:15pm ET (11:30am ET) on day -1 and 4:15pm ET (11:30am ET) on day and 0 oherwise,,*,** is a (9x8) binary marix for he eigh individual European news announcemens wih being a (3x8) [(6x8)] binary marix,*,** he (i,j)-h elemen of which is a dummy variable ha akes he value one when an announcemen for he j-h individual European economic variable occurs beween 4:15pm ET (11:30am ET) on day -1 and 4:15pm ET (11:30am ET) on day and zero oherwise, Hadamard producs and ε is a (9x1) vecor of residuals. 18 and are We also examine wheher implied volailiy spillovers persis afer he surprise effec of individual news announcemens is aken ino accoun. Hence, H4b is formulaed: H4b: Implied volailiy spillovers do no exis once we accoun for he surprise effec of he individual releases. ΔIV C ΦΔIV ε (11) 1

19 where 1, , 6 12 and 1, 3 8 2, 6 8 are marices of coefficiens [(9x12) and (9x8), respecively],,*,** is a (9x12) marix of he surprise componen of he individual U.. news announcemens wih being a (3x12) [(6x12)] marix of he surprise componen,*,** of he individual U.. announcemens ha occur beween 4:15pm ET (11:30am ET) on day -1 and 4:15pm ET (11:30am ET) on day,,*,** is a (9x8) marix of he surprise componen of he individual European news announcemens wih being a (3x8) [(6x8)] marix of,*,** he surprise componen of he individual European announcemens ha occur beween 4:15pm ET (11:30am ET) on day -1 and 4:15pm ET (11:30am ET) on day, Hadamard producs and ε is a (9x1) vecor of residuals. 19 and are Tables 10 and 11 show he resuls for he VR(1) model augmened by he dummy [H4a, equaion (10)] and surprise variables [H4b, equaion (11)] for he individual news announcemen iems, respecively. In Table 10 we can see ha volailiy conagion is presen since implied volailiy spillovers are preserved jus as was he case wih he announcemen effec of aggregae releases. Furhermore, individual news announcemen iems do no affec he dynamics of implied volailiy indices. The only excepion occurs for he U.. GP releases ha have an impac on mos volailiy indices and for he U.. FOMC announcemens ha affec only he U.. indices. imilar findings are obained in he case where he conen of news announcemens is considered. More specifically, in Table 11 we can see ha volailiy spillovers persis and he unexpeced componen of individual news announcemens does no affec he dynamics of implied volailiy indices eiher. The only excepion occurs for he U.. CCI and he FOMC ha affec he U.. implied volailiy indices and he -CCI ha affecs he European ones. These resuls are in line wih he findings for he regional releases where European releases were found o be significan only when heir conen is considered (see ecion 4.3). They are also analogous o he findings of Connolly and Wang (1998) who repored ha news announcemens show up less evidenly when hey are considered a an individual and no regional level. Ineresingly, he fac ha he U.. CCI and -CCI releases are found o be significan in

20 he case where hey are modeled as surprises raher han evens, is in accordance wih he marke efficiency heory. Furhermore, his implies ha he conen of hese wo news announcemen iems needs o be aken ino accoun for he purposes of explaining he dynamics of implied volailiy. imilarly, he finding ha FOMC releases affec implied volailiy dynamics, irrespecively of wheher hese are measured as dummy or surprise variables, is also in line wih he marke efficiency heory. On he oher hand, he fac ha he U.. GP news announcemens affec significanly mos volailiy indices when hey are considered merely as evens raher han surprises is no consisen wih he marke efficiency hypohesis. This is because his resuls implies ha he dynamics of implied volailiy are affeced by he expeced (i.e. iming) and no he unexpeced (i.e. surprise) componen of he U.. GP releases. 5 The effec of news announcemens on he magniude of implied volailiy spillovers In his secion, we invesigae wheher news announcemens affec he magniude of implied volailiy spillovers. 13 To his end, he announcemen and surprise effec of aggregae and regional releases is explored by employing a VR(1) model ha allows for he marix of coefficiens of he auoregressive erms o be affeced by he news announcemens. 5.1 ggregae news releases: nnouncemen and surprise effecs Firs, we examine wheher he magniude of implied volailiy spillovers is he same on announcemen and non-announcemen daes when aggregae news announcemens are considered. Thus, he following hypohesis is esed: H5a: ggregae releases do no have an announcemen effec on he magniude of implied volailiy spillovers. To es his hypohesis, he following specificaion is esimaed by using he UR mehodology: ΔIV C ΔIV ε (12) 1 13 The magniude of implied volailiy spillovers may also depend on oher variables ha measure he degree of inegraion of he counries under consideraion. The exernal rade would have been a naural choice o use as a conrol variable (see e.g., ornbusch e al., 2000). We do no invesigae his because rade daa are no available a a daily frequency. 20

21 where C is a (9x1) vecor of consans, and 1, 3 9 2, 6 9 are (9x9) marices of coefficiens, * ** is a (2x1) binary vecor wih being a dummy variable ha akes he value 1 * ** when he announcemen for any economic variable occurs beween 4:15pm ET (11:30am ET) on day -1 and 4:15pm ET (11:30am ET) on day and 0 oherwise, 1 2 * ** is a Khari- Rao produc and ε is a (9x1) vecor of residuals. Noe ha equaion (12) allows for he marix of he coefficiens of he auoregressive erms o be affeced by he aggregae news announcemens wihin a VR modeling framework (see for a similar approach e.g., Connolly and Wang, 1998, who examine he impac of news announcemens wihin a reurn spillover framework). Nex, we examine wheher he magniude of implied volailiy spillovers is he same on announcemen and non-announcemen days when he conen of aggregae news announcemens is considered. The impac of he surprise elemen of aggregae news announcemens on he magniude of implied volailiy spillovers is also invesigaed. To his end, he following hypohesis is considered: H5b: ggregae news announcemen surprises do no have any effec on he magniude of implied volailiy spillovers. To es his hypohesis, he marix of he coefficiens of he auoregressive erms is allowed o be affeced by he aggregae surprise componen of news announcemens wihin a VR modeling framework. Hence, he following specificaion is esimaed by using he UR mehodology: ΔIV C ΔIV ε (13) 1 where C is a (9x1) vecor of consans, and 1, 39 2, 6 9 are (9x9) marices of coefficiens, * ** is a (2x1) vecor wih being he aggregae surprise componen of he * ** announcemens for any economic variable ha occur beween 4:15pm ET (11:30am ET) on day -1 21

22 and 4:15pm ET (11:30am ET) on day, (9x1) vecor of residuals. 1 2 * ** is a Khari-Rao produc and ε is a Tables 12 and 13 show he resuls for he announcemen [H5a, equaion (12)] and surprise effec [H5b, equaion (13)] of releases on he magniude of implied volailiy spillovers, respecively. In Table 12 we can see ha he announcemen effec of aggregae releases is weak, since aggregae news announcemens do no affec he magniude of implied volailiy spillovers in mos cases. The only excepion occurs for VEL, VMI and VTOXX. In paricular, aggregae releases affec he magniude of he impac of VEL o all European implied volailiy indices, and he impac of VMI and VTOXX o mos U.. and European volailiy indices. Ineresingly, he repored weak announcemen effec is analogous o Karolyi and ulz (1996) who also used aggregae releases and found ha sock reurn co-movemens are he same on announcemen and non-announcemen days. Table 13 shows ha he surprise effec of aggregae releases is sronger han heir respecive announcemen effec. This is because he surprise elemen of aggregae news announcemens has an impac on he magniude of implied volailiy spillovers in many cases. In paricular, we can see ha aggregae releases affec he impac of VIX, VX, VCC and VMI on mos volailiy indices, ha of VX and VEL on all U.. indices, and ha of VTOXX on mos European ones. These findings sugges ha he conen of news announcemens (and no heir occurrence) needs o be considered for he purposes of examining he magniude of volailiy spillovers. 5.2 Regional news releases: nnouncemen and surprise effecs Nex, we disinguish beween releases of U.. and European economic variables and invesigae wheher he magniude of implied volailiy spillovers is he same on announcemen and nonannouncemen days when regional news announcemens are considered: H6a: The U.. and European releases do no have an announcemen effec on he magniude of implied volailiy spillovers. H6a is esed by considering a VR modeling framework where he marix of coefficiens of he auoregressive erms is allowed o be affeced by he regional aggregae news announcemens. Hence, he following specificaion is esimaed by using he UR mehodology: 22

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