Implied Volatilities From a Behavioural Finance Perspective

We have discussed at length the implied volatility and its relationships with realized volatility, volatility skew, dividend yield, and correlations. Moreover, it is interesting to examine implied volatility from a behavioural finance perspective. Reference [1] studied the relationship between various countries' implied volatilities and their cultural characteristics. Specifically, it utilized Hofstede's six measures of national culture [2] to examine the implied volatilities of 15 countries. These measures are:

• Power Distance (PDI),
• Individualism vs. Collectivism(IDV),
• Masculinity vs. Femininity (MAS),
• Uncertainty Avoidance (UAI),
• Long-term vs. Short-term Orientation (LTOWVS) and
• Indulgence vs. Restraint (IVR).

The countries in the study are Australia, Belgium, Canada, France, Germany, Hong Kong, India, Japan, Mexico, the Netherlands, the Russian Federation, South Korea, Sweden, Switzerland, the United Kingdom, and the USA. The author pointed out,

This paper confirms the significant long-term statistical relationship between national culture and equity market volatility levels…The five main findings in this study are summarized as follows:

(1) The market volatility level will be higher if market participants accept a hierarchical order in which everybody has a place and which needs no further justification (PDI), or if they prefer a loosely knit society in which individuals are expected to take care of only themselves and their immediate families (IDV).

(2) The market volatility level will be lower if the members of a society feel uncomfortable with uncertainty and ambiguity (UAI).

(3) The market volatility level will be higher for both highly masculine and highly feminine societies. The volatility level will be lower when the measure rests around the medium level of MAS. A society with a high MAS index prefers achievement, heroism, assertiveness and material rewards for success. This type of society values cooperation, modesty, caring for the weak, and quality of life.

(4) The market volatility level will be higher for both highly normative and highly pragmatic societies with high and low LTOWVS indices, respectively. The volatility level will be lower if the measure rests around the medium level of the LTOWVS index. ..

 (5) Societies with high levels of either indulgence or restraint demonstrate a lower volatility level. Indulgence represents a society that allows for the enjoyment of life and having fun. Restraint represents a society that suppresses the gratification of needs and desires.

In short, there is a link between implied volatility and cultural characteristics.

This is an interesting area of research. Let us know what you think in the comments below or in the discussion forum.

References

[1]  Wei-han Liu, National culture effects on stock market volatility level, Empirical Economics (2019) 57:1229–1253

[2] Hofstede GH (1980) Culture’s consequence. Sage Publications, New York

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