Ranjini Jha

Idiosyncratic Return Volatility and the Information Quality Underlying Managerial Discretion

Variation in idiosyncratic return volatility from 1978 to 2009 is attributable to discretionary accrual volatility and the correlation between premanaged earnings and discretionary accruals reflective of information quality across firms. These results are robust to controls for firm operating uncertainty, growth options, business-cycle variations, and firm age and industry effects, and they highlight the importance of managerial discretion in determining idiosyncratic volatility.

The Economic Value of Using Realized Volatility in Forecasting Future Implied Volatility

We examine the economic benefits of using realized volatility to forecast future implied volatility for pricing, trading, and hedging in the S&P 500 index options market. We propose an encompassing regression approach to forecast future implied volatility and hence future option prices by combining historical realized volatility and current implied volatility. An analysis of delta-neutral straddles and naked and delta-hedged option positions shows that the statistical superiority of historical realized volatility demonstrated in the encompassing regressions and option pricing errors does not translate into economic gains, when trading and hedging in the options markets, after considering trading costs.

Stock and Option Proportions in Executive Compensation

There is controversy about the relative merits of stock and options in executive compensation. Some observers contend that stock is a more efficient mechanism, while others reach the opposite conclusion. We focus on the managers risk-taking incentives and derive an optimal compensation contract by using the concept of a comparable benchmark and imposing a volatility constraint in a principal-agent framework. We demonstrate a joint role for both stock and options in the optimal contract. We show that firms with higher volatility should use more options in compensating their executives and provide empirical evidence supporting this testable implication.

The Economic Value of Using Realized Volatility in the Index Options Market

We examine the economic benefits of using high frequency volatility measures for pricing, trading and hedging in the S&P 500 index options market. Using the encompassing regression framework, we generate volatility forecasts combining information from long memory high-frequency volatility specifications and option-based implied volatilities. We conduct out-of-sample tests of the volatility forecasts by examining option pricing performance, trading performance based on volatility timing strategies, and the performance of covered options positions for index option writers. Our results support combining forecasts of implied volatility and realized volatility and illustrate that the realized volatility approach has economic value in the context of option pricing and risk management.