Exploring stochastic volatility in financial market

Abstract

Financial markets areconstantly fluctuating in response to a range of factors. These fluctuations connote volatility which are unpredictable behaviour that deviates significantly from the patterns observed in stable conditions. It is therefore important to use standard stochastic volatility models to capture the time-varying nature of volatility during periods of financial distress in other to make informed decisions. The aim of this study was to explore stochastic volatility in financial markets during periods of financial distress using a Heston model. The sample financial markets were, the CAC 40, the DAX, the JSE, the Nasdaq Index and the Nikkei-225. The 2007/2008 financial crisis and the Covid-19 pandemic were used as sample time frames. The findings of this study revealed extortionate stochastic volatility during the Covid-19 pandemic compared to the 2007/2008 financial crisis. Since the 2007/ 2008 crisis stemmed from a collapse in the financial system, the nature of the event was more localized within the financial sector and had a somewhat more predictable unfolding than the Covid-19 pandemic. By Implication, it may be suggested that it was more difficult to price assets during the Covid-19 pandemic due to extreme uncertainty which resulted in inflated option premiums as investors sought hedging strategies.

Keywords: {'name': 'Stochastic volatility; Heston model; financial distress; Covid-19 pandemic; asset pricing'}

Authors & affiliations

Samuel Tabot Enow
Affiliation not supplied

Deposited references

Supplied references, not a list of publications citing this article.

DOI: 10.1016/j.jfineco.2005.10.006

DOI: 10.2139/ssrn.317921

DOI: 10.1093/rfs/9.1.69

Black, F. (1976). Studies of stock price volatility changes. Proceedings of the Business and Economics Section of the American Statistical Association, 177–181.

DOI: 10.1086/260062

DOI: 10.21511/pmf.05(4).2016.02

DOI: 10.1086/261527

DOI: 10.1287/mnsc.1090.1065

DOI: 10.1111/1467-9965.00057

DOI: 10.1111/j.1540-6261.1976.tb01893.x

DOI: 10.2469/faj.v52.n4.2008

Dupire, B. (1994). Pricing with a smile. Risk, 7(1), 18–20.

DOI: 10.2307/1912773

DOI: 10.32479/ijefi.13752

DOI: 10.32479/ijefi.13996

DOI: 10.3917/fina.352.0057

DOI: 10.2307/3318718

Gerlach, S., Ramaswamy, S., & Scatigna, M. (2006). 150 years of financial market volatility. ResearchGate. Available online: https://www.researchgate.net/publication/228291637_150_Years_of_Financial_Market_Volatility

DOI: 10.1080/07350015.1996.10524672

DOI: 10.1093/rfs/6.2.327

DOI: 10.1111/j.1540-6261.1987.tb02568.x

DOI: 10.2202/1558-3708.1226

DOI: 10.1080/03461238.2021.1873176

DOI: 10.1016/0304-405X(76)90022-2

DOI: 10.3390/risks8020035

DOI: 10.1007/BF02927152

Opschoor, A. (2014). Understanding financial market volatility. Tinbergen Institute. Available online: https://repub.eur.nl/pub/50526/RP_Anne-Opschoor-Tinbergen-lr-.pdf

DOI: 10.1214/09-AOAS286

DOI: 10.1093/rfs/4.4.727

Taylor, S. J. (1986). Modelling financial time series. Wiley.