Why Equity Implied Volatility Skews Differ Across Markets
Summary
The document considers whether some equity markets still have nearly flat implied volatility smiles, in contrast with the negative skew often associated with major indices after the 1987 crash. One response reports that options on many Korean equities, and some Japanese equities at certain maturities, showed relatively flat implied volatility. This is an illustrative observation rather than a broad survey across markets or a claim that the pattern persists.
The discussion gives supply and demand as another explanation for negative skew: investors seek downside protection, while structured-product demand and put financing can affect the supply of puts and calls. It cautions against inferring that emerging markets have lower crash risk merely because they have less automated trading or integration. Index volatility can rise during declines as constituents move together; indiscriminate selling may increase correlation, and manual trading does not necessarily reduce that effect. The document offers possible mechanisms and examples, not a systematic empirical test.
Key ideas
- Options on many Korean equities and some Japanese equities were described as having relatively flat implied volatility at the time discussed.
- Negative volatility skew can reflect option supply and demand as well as perceived crash risk.
- Demand for portfolio protection can raise the relative price of downside options.
- Lower automation in a market does not establish that its crash risk is lower.
- Constituent co-movement during a market decline can raise index volatility.
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Full text
# Indexes/stocks with flat implied volatilities # Indexes/stocks with flat implied volatilities After the 1987 crash, the S&P500 index implied volatility changed from nearly flat to negatively sloped. According to Rubinstein the Black-Scholes model was not so wrong when applied to the S&P500 before 1986-87. I am wondering if there are still indexes or stocks around the world that present almost flat implied volatility. I have the feeling this should be true in emerging countries where the risk of crash is lower (no electronic-trading, less globalization of exchanges and thus less systematic risk) but I did not find any evidences online yet. ## Answer by Eli (score 5, accepted) https://quant.stackexchange.com/a/4107 Options on almost all Korean equities today present flat implied volatility, as well as options on some Japanese equities, especially in 60-90 days maturity. Here how the smile looks for T&D Holdings (ISIN:JP3539220008): ## Answer by joelhoro (score 1) https://quant.stackexchange.com/a/4048 The negative slope is not just because people think there is going to be a crash, it is also just function of supply and demand on options: - Many investors want to buy protection on their portfolio, and there is no natural seller so it's the speculator who end up taking that side of the bet, but obviously only if there is a sufficient premium - with low interest rate, people have less money to spend when they do capital guaranteed structures, so whenever they buy puts they will usually also sell calls to cheapen the total option price. This again will create extra supply Besides, the thing about lack of automated trading in some emerging markets might be true, but that might not necessarily mean reduced crash risk. One of the reasons that the vol of an index goes up when the index goes down is that people just trade all the constituents without much discrimination, which pushes the correlation up, hence the vol of the index. That might actually be worse when performed manually by humans than when done by machines which could potentially correct for imbalances between shares (i.e. sell bad ones and refrain from selling good ones).
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